The Simple, Naive, Keynsian Model [SNKM] tells us that if the govt injects some new spending into the spending stream, the new spending becomes someone else's income which in turn gets spent, becoming someone else's income, etc. etc. In its very simplist form, this "multiplier" effect means that national income would increase by an amount equal to the increase in govt spending times 1/MPS, where MPS is the marginal propensity to save (the percentage of each additional dollar of income that is spent on consumption).
When I was an undergraduate economics student 68 years ago, my roommate and I figured that something must be wrong with the SNKM because if the MPS was .1 or smaller, then the SNKM multiplier had to be at least 10 and maybe higher! We were understandably skeptical: if the govt could increase incomes and spending tenfold with every dollar of increased govt spending, we were sure they should be doing it.... a lot!
Much later, as I began to understand more about search and the natural rate of unemployment, it became clear to me that the long-run aggregate supply curve is vertical (or nearly so). And if that's the case, then in the long run, the fiscal multiplier must be zero: shifting aggregate demand can affect only prices, not output or income.
But what about the short-run?
In the extreme case, if the aggregate supply curve is horizontal, we might get a SNKM type of multiplier (with no price effects). Even then, though, if there are substantial leakages as some spending goes for imported goods, some income gets siphoned off to various levels of govt via taxes, and as increased govt borrowing drives up interest rates and crowds out borrowing for investment and consumption spending, then even the short-run Keynesian multiplier is likely to be pretty small.
Add in the fact that rarely, if ever, is the aggregate supply curve horizontal; add in the fact that there is almost always some price effect (i.e., only under extreme conditions might the aggregate demand curve be vertical); and add in the impact of Ricardian Equivalence* whereby people save more and spend less to provide for future tax liabilities when the govt deficit increases; add all those things in, and it is hard to imagine that the short-run multiplier would be larger than maybe 0.5, if that.
So imagine my surprise when I read Arnold Kling's posting in which he said the Keynesian multiplier is currently about 3.
Logic suggests that the multiplier today is large. It more likely to be closer to 3 (or above) than to 1.
1. Interest rates on Treasuries are so low that printing Treasuries is tantamount to printing money.
2. Unless the fiscal stimulus is really stupidly targeted, there
should be few supply bottlenecks. The demand increase will go mostly to
output and hardly at all to prices.
3. Investment is more likely to be "crowded in" by stronger demand than crowded out by higher interest rates.
4. We are likely to see a strong "Minsky effect." That is, higher
income should increase wealth and improve balance sheets. This will
stimulate spending by both businesses and consumers.
His point #1 is saying that there is not likely to be much crowding out, at least not due to any interest rate effects.
His point #2 says that the aggregate supply curve is pretty flat, so that shifts of the aggregate demand curve will have a big impact on output and incomes.
I am not quite sure what he means by point #3. It might be that as incomes grow, businesses come to expect that consumption and investment spending will increase and hence the businesses spend more on investment.
And point #4 seems to be akin to a wealth or "permanent income" effect: cet. par., an increase in wealth leads to an increase in spending.
I'm willing to grant these points, to some extent. And I can even imagine that a Keynesian multiplier might sometimes be quite high in the very short run. At the same time, though, keep in mind that govt meddling with the economy creates considerable uncertainty about property rights, incomes, and appropriate expectations. This uncertainty (and the attendant risk) encourages businesses and consumers to save more and spend less, thus reducing the size of the multiplier.
At the same time, as consumers deleverage (i.e. start saving instead of dissaving) increases in wealth and income will most likely, over the next few months at the very least, lead to very small (if any) increases in aggregate demand. If planned saving increases at the same time the fiscal deficit increases, the net effect on aggregate demand could well be zero. And if that's the case, even in the short-run, the multiplier will be very, very small.
*Ricardian Equivalence is named for the economist who discovered the phenomenon, Professor Equivalence.
