Sunday, November 27, 2011

Keynes' Multiplier

The primary explanation used by Keynes to explain why public investment would spark economic growth and hiring was his "multiplier" theory.  The idea was that public money spent on hiring the unemployed to build infrastructure projects would cause an infusion of money into the economy and expand the monetary base causing the economy to grow.  Each dollar spent would have a multiplicative effect on the economy.  Of course, now we know it did not work.  It failed in the 1930s and again after the Global Financial Crisis of 2008. 

Why did it fail?  N theory shows that it is wealth that the economy runs on, not money.  Money is just a placeholder.  Money acts like a barter exchange unless there is a profit activity.  In a barter economy there is no wealth creation beyond the production of more goods which cannot occur unless the factors of production are free, and that is the situation in only the most primitive societies.  It is only in a society with a banking system that expansion of the Money Supply occurs and provides the opportunity for wealth creation.  Profit accumulation is the only method of Wealth creation.  Profit acts like an asset allowing a bank to make further loans and expand the Money Supply and provide the opportunity for more profit accumulation.

Keynes' monetary expansion since it created public assets, public infrastructure, failed to create a profit making Private Sector asset.  The public assets are of no wealth creating value.  The Public Sector borrows based on their tax base not public assets.  The tax base was not expanded by building public infrastructure.  No wealth creation occurs in this process unless the constructor is in the Private Sector and makes a substantial persistent profit over time.  Typically, infrastructure projects are one time events limiting the consistency of the profit stream and therefore diminishing the economic effectiveness.

Keynes felt more money in the hands of the unemployed would spark some economic expansion.  Now we can see that this did not occur, but it should have been predictable.  In a economic downturn businesses are struggling.  An injection of a little cash is much appreciated, but it is unlikely to be enough to make a business person hire new employees or expand.  It only sustains them in a difficult time.  Insufficient wealth is created to change a business person's perspective. 

A business person's perspective will only change when the outlook for the economic future changes.  This is why the Great Depression lasted until WWII.  This is why the Great Recession will last until there is a change in economic outlook.  Since government is impotent they should stop screwing with the economy.     

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