Economics Dictionary of ArgumentsHome
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| Investment multiplier: The investment multiplier in economics is a factor that indicates the effect of an investment on another variable. See also J.M. Keynes, Consumption function. See also Investments._____________Annotation: The above characterizations of concepts are neither definitions nor exhausting presentations of problems related to them. Instead, they are intended to give a short introduction to the contributions below. – Lexicon of Arguments. | |||
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Milton Friedman on Investment Multiplier - Dictionary of Arguments
Landsburg I 7 Investment multiplier/Friedman/Landsburg: „Keynesian Multiplier“: Example: If you want people to spend more, you should start by raising their incomes. Encourage your government to hire Alice and raise her salary by a dollar. She'll spend an extra 90 cents or so - and that's only the beginning. If she spends that 90 cents at the butcher shop or the hair salon or the craft brewery, then the butcher or the beautician or the brewer earns an extra 90 cents and probably spends about 90 percent ofthat, which raises yet someone else's income, and off we go. When all is said and done, one dollar of additional government spending can raise total spending (and total income) by $ 10 or more. That's the story of the so-called "Keynesian multiplier." Once upon a time, pretty much all economists considered it a cornerstone of policymaking. FriedmanVsKeynes: Here's the problem: Income is indeed highly correlated with spending. But correlation is not causation. When Alice out-earns Bob by a dollar, she typically outspends him by 90 cents. But her current earning is not the cause of that spending. Instead, she outspends him (in most cases) because she expects to continue to out-earn him for many years to come. As a general rule, people calibrate their spending not to their current incomes but to their permanent incomes - that is, to something like their expected lifetime earnings. Now if Alice gets a $ 1 yearly raise from her private employer, she's likely to believe - correctly! - that the raise is probably permanent. That's why she spends more, and that's why the data show that higher incomes usually go hand-in-hand with higher spending. But if, instead, Alice gets a $ 1 yearly raise from a government that has decided to temporarily ramp up spending, she'll probably want to squirrel most of that dollar away against the day when her salary returns to normal. The cycle of spending we called the Keynesian multiplier never gets off the ground. >Permanent Income Hypothesis/Friedman. Wrong solution: Maybe the cure is for the government to hire Alice and permanently raise her salary by $ 1 a year. That sounds good until you start thinking about where the government is going to get that dollar every Year: a) The government could raise Bob's taxes by a dollar a Year. But then just as Alice's spending goes up, Bob's goes down. If you want to increase total spending, this gets you nowhere. b) The government could borrow a dollar from Bob every year. But eventually Bob is going to want to be paid back, at which point the government is going to have to raise Charlie's taxes to get the money. At that point, Charlie starts spending less. Landsburg I 8 Worse yet, if Charlie follows the news, he's likely to realize today that the government is running up debt, that future taxes are likely to rise, and that his own permanent income has therefore a taken a hit, which means he'll reduce his spending immediately. Problem: If you want Alice to spend more, you have to increase her permanent income, not just her current income. But the government can't increase Alice's permanent income without decreasing Bob's or Charlie's permanent income by the same amount, which dooms the entire project to failure.* That's one consequence of Milton Friedman's permanent income hypothesis. >Permanent Income Hypothesis/Friedman. *There are occasional exceptions. Conceivably the government could build a highway that reduces transportation costs by so much that everyone's permanent income - even after factoring in the taxes they pay to build the highway - goes up. Unfortunately, most government projects are not that productive._____________Explanation of symbols: Roman numerals indicate the source, arabic numerals indicate the page number. The corresponding books are indicated on the right hand side. ((s)…): Comment by the sender of the contribution. Translations: Dictionary of Arguments The note [Concept/Author], [Author1]Vs[Author2] or [Author]Vs[term] resp. "problem:"/"solution:", "old:"/"new:" and "thesis:" is an addition from the Dictionary of Arguments. If a German edition is specified, the page numbers refer to this edition. |
Econ Fried I Milton Friedman The role of monetary policy 1968 Landsburg I Steven E. Landsburg The Essential Milton Friedman Vancouver: Fraser Institute 2019 |
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