Irish Liberty Forum

Confusion Multiplies

with 2 comments

When governments of the world agreed to collectively counteract the global turndown, they did not agree to a global “stimulus package”. This however will not stop the industrialised nations attempting such a stimulus packages individually. The UK government, for instance have already bowed to Keynesian depression economics. The idea behind these packages is that George Bush and co. can “jumpstart” the global economy by getting people to start spending again.

This plan is justified by the following paragraph I read on a message board:

If you tax and spend using progressive tax you take 1 euro from a rich man (who would otherwise spend it on imports) and give it to a teacher or other worker who has a higher marginal propensity to consume. That teacher then spends it and it goes into someone elses hands and so on indefinitely. This multiplier effect means that government spending can get us out of a recession. In fact if the marginal propensity to consume is 0.9 (a person who gets a euro spends 90c) then the output effect of the government spending 1 euro is 1/(1-0.9)=10!

So the more we spend, the more the economy grows.

The above is a horrible misrepresentation of how the economy works. In order for any consumption to occur there must first be production. This is summarised by Say’s Law: supply creates it’s own demand.

It doesn’t matter how many green pieces of paper are in your wallet; you can’t “demand” a TV set unless the store has an actual unit on the shelf. Pushing it back one step, no matter how many customers are lining up outside his store, the manager of Best Buy can’t stockpile his shelves with TVs unless the manufacturer has previously assembled them. And of course, the manufacturer can’t do so—regardless of how much money he is offered by the Best Buy manager—unless he can find enough workers, and enough of the relevant parts, to actually make the TVs.

In the Keynesian model of the economy, it is as if the economy is entirely composed of retailers, whereas manufacturers produce consumer goods by snapping their fingers. The multiplier only exists if this is true. However it is obviously not. The economy is made up of various stages of production, which must work to produce the goods that are finally purchased and consumed.

A lot of the “paradoxes” of Keynesian economics would be solved if the “circular flow diagram” of the economy were replaced with the Hayekian Triangle model; a more accurate depiction of the world in which we live.


Written by 20000miles

November 21, 2008 at 5:47 pm

2 Responses

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  1. […] Stimulus won’t work I’ve known this for a while and I’d like to give my take: When governments of the world agreed to collectively counteract the global turndown, they did not […]

  2. Why can’t governments see that you cannot borrow and spend your way to prosperity.


    February 17, 2009 at 7:32 pm

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