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11. Money and Its Purchasing Power > 17. Further Fallacies of the Keynesian System

C. The Multiplier

The once highly esteemed “multiplier” has now happily faded in popularity, as economists have begun to realize that it is simply the obverse of the stable consumption function. However, the complete absurdity of the multiplier has not yet been fully appreciated. The theory of the “investment multiplier” runs somewhat as follows:

Social Income = Consumption + Investment

Consumption is a stable function of income, as revealed by statistical correlation, etc. Let us say, for the sake of simplicity, that Consumption will always be .80 (Income).76 In that case,

Income = .80 (Income) + Investment.
.20 (Income) = Investment; or
Income = 5 (Investment).

The “5” is the “investment multiplier.” It is then obvious that all we need to increase social money income by a desired amount is to increase investment by 1/5 of that amount; and the multiplier magic will do the rest. The early “pump primers” believed in approaching this goal through stimulating private investment; later Keynesians realized that if investment is an “active” volatile factor, government spending is no less active and more certain, so that government spending must be relied upon to provide the needed multiplier effect. Creating new money would be most effective, since the government would then be sure not to reduce private funds. Hence the basis for calling all government spending “investment”: it is “investment” because it is not tied passively to income.

The following is offered as a far more potent “multiplier,” on Keynesian grounds even more potent and effective than the investment multiplier, and on Keynesian grounds there can be no objection to it. It is a reductio ad absurdum, but it is not simply a parody, for it is in keeping with the Keynesian method.

Social Income = Income of (insert name of any person, say the reader) + Income of everyone else.

Let us use symbols:

Social income = Y
Income of the Reader = R
Income of everyone else = V

We find that V is a completely stable function of Y. Plot the two on coordinates, and we find historical one-to-one correspondence between them. It is a tremendously stable function, far more stable than the “consumption function.” On the other hand, plot R against Y. Here we find, instead of perfect correlation, only the remotest of connections between the fluctuating income of the reader of these lines and the social income. Therefore, this reader's income is the active, volatile, uncertain element in the social income, while everyone else's income is passive, stable, determined by the social income.

Let us say the equation arrived at is:

This is the reader's own personal multiplier, a far more powerful one than the investment multiplier. To increase social income and thereby cure depression and unemployment, it is only necessary for the government to print a certain number of dollars and give them to the reader of these lines. The reader's spending will prime the pump of a 100,000-fold increase in the national income.77

  • 76. Actually, the form of the Keynesian function is generally “linear,” e.g., Consumption = .80 (Income) + 20. The form given in the text simplifies the exposition without, however, changing its essence.
  • 77. Also see Hazlitt, Failure of the “New Economics,” pp. 135–55.