On the Mythology of the Keynesian Multiplier: Unmasking the Myth and the inadequacies of Some Earlier Criticisms - Focus on Economic Theory - John Maynard Keynes

American Journal of Economics and Sociology, The, Oct, 2001 by James C. W. Ahiakpor

JAMES C. W. AHIAKPOR (*)

ABSTRACT. Keynes's multiplier story invites acceptance by building on the fact that people typically consume only a fraction of their income and that such purchases are incomes for sellers. By misrepresenting the classical definition of saving and the meaning of Say's Law, Keynes laid the grounds for extolling the virtues of consumption spending as determining income and employment growth. But the mythology of the multiplier story becomes clear when we ask, "From where do people find the means to purchase consumption goods, other than production?" The inadequacies of several earlier criticisms stem from their failure to focus on this fundamental point.

I

Introduction

THE MULTIPLIER IS ONE OF THE MAIN building blocks of Keynes's aggregate demand management and income (employment) creation theory. Keynes (1936) focuses on consumption spending as the principal determinant of income growth, arguing that consumption releases purchasing power to producers and thereby validates their investment plans. Saving plays no positive role in supplying the funds for investment in Keynes's reasoning. He states, for example, "The investment market can become congested through the shortage of cash. It can never become congested through the shortage of saving" (1937:669), and "Saving has no special efficacy as compared with consumption, in releasing cash and restoring liquidity" (1938:321). Consumption spending thus is the means through which an initial amount of expenditure creates a multiplier effect. In a simplified model, [DELTA]Y = k[DELTA]Z = (1/s) [DELTA]Z where Y is nominal income (GDP), k is the multiplier, s is the marginal propensity to save, and Z is some "autonomous" expenditure , such as investment or government expenditure that does not depend on domestic savings. Keynes (1933, 1936), by his elaboration of Richard Kahn's earlier (1931) argument, thus exalts consumption spending to a magical significance in macroeconomic analysis, contrary to the classical emphasis on production and saving for investment in order to promote the growth of output and employment (Ahiakpor 1995). Such popular claims as "the current U.S. economic expansion is being driven by consumer spending" also reflects the Keynesian multiplier view.

The Keynesian multiplier analysis has become a staple in macroeconomic education at the introductory and higher levels, without students being warned of the concept's fundamental misrepresentation of how an economy works. See, for example, Boyes and Melvin (1994), Case and Fair (1996), Gwartney, Stroup, and Sobel (2000), Mankiw (1998), O'Sullivan and Sheffrin (1998), Parkin (1997), Samuelson and Nordhaus (1998), Stiglitz (1997), and Taylor (1998) at the introductory level, and Abel and Bernanke (1998), Blanchard (2000), Dornbusch and Fischer (1994), Froyen (1999), Mankiw (1997), McElroy (1996), Galbraith and Darity (1994), Gordon (2000), and Hall and Taylor (1993) at higher levels.

Some previous analysts have cast doubts on the validity or meaningfulness of Keynes's argument, such as Pigou (1933, 1941), Robertson (1936), Hawtrey (1950, 1952), Hazlitt (1959), Haberler (1960), Rothbard (1962), and Hutt (1974), but with hardly any success in limiting its widespread acceptance and teaching in macroeconomics. Stockman (1999:300-311) comes close to showing the error of the Keynesian argument by his references to "indirect effects," but nevertheless fails to give a clear refutation of the Keynesian multiplier argument because of his conceding an expansionary effect of consumption spending through a change in the rate of interest. In this article, I argue that the earlier criticisms have not been effective mainly because they miss pointing out the real illusion of the Keynesian multiplier story. (1) If one asked some fundamental questions, such as "From where does the initial spender get the income to spend?" or "What is saving other than the purchase of financial assets and not the hoarding of cash?" (the classical definition of saving) we find that the Keynesian multiplier story is more of a myth than an accurate description of the economic process.

The source of income growth is production, albeit in anticipation of demand, just as Adam Smith, David Ricardo, and other classicals have explained. No one consumes without first having earned income from production or borrowed someone else's income. Moreover, the income generation process in an economy is a concurrent one, not the unidirectional process described in the Keynesian multiplier story. And saving (not the hoarding of cash) is not a leakage from the income-expenditure stream; it is the main source of investment finance. Thus, the multiplier, if one existed, is not the inverse of the marginal propensity to save. Indeed, the closest we come to the multiplier concept is the productivity of investment or the incremental output-capital ratio, (2) but these do not depend on the marginal propensity to consume as the Keynesian multiplier argues. It is also a mistake to interpret earlier arguments (as by Walter Bagehot, N. A. L. J. Johannsen, J. Wullf, Alfred Schwoner, A. C. Pigou [Hegeland 1954], L. F. Giblin, and Ralph G. Hawtrey [Dimand 1988, 1997]) of a change in production or demand in one sector of an economy having "multiplying effects" throughout the economy as precursors of the Keynesian multiplier story. Ahiakpor (2000) elaborates on the error of such claims by Dimand (1988, 1997) and Darity and Young (1997).