Keynesian Multiplier & Fiscal Policy Impact
The Keynesian Multiplier and Its Impact
The Keynesian Multiplier concept suggests that changes in public expenditure can offset changes in private demand. An increase in public spending boosts domestic production and agents’ disposable income. This increased income, in turn, fuels consumer demand and investment, leading to further production increases, generating more income, and so on.
Haavelmo Theorem and the Ripple Effect
Conclusion 1 (Haavelmo Theorem): An increase in government spending results in greater growth in aggregate demand compared to a tax cut of the same amount. This difference arises because spending directly contributes to aggregate demand, while a tax reduction doesn’t immediately increase demand. A portion of the increased disposable income from tax cuts may be saved rather than consumed. The magnitude of this effect depends on the propensity to consume versus save. The increased production is precisely equal to public spending, as stated by the Haavelmo Theorem.
Conclusion 2 (Ripple Effect): An increase in public spending creates a ripple effect on economic activity, even when fully funded by tax increases (i.e., maintaining a balanced budget). The Keynesian perspective posits that any deficit caused by increased public spending is temporary, as the ensuing economic recovery will generate new tax revenues, offsetting the initial spending.
The Role of Automatic Stabilizers
Automatic stabilizers are budget components that automatically exert a cyclical effect on economic activity, independent of discretionary fiscal policy. Taxes and transfers are the most significant budget items with stabilizing power. During recessions, as economic activity declines, tax revenues decrease, while transfer payments (e.g., unemployment benefits) increase. These transfers mitigate the decline in household disposable income and business revenue, cushioning the fall in demand for consumer goods and capital formation.
During economic expansions, the budget tends towards a surplus. Disposable income grows at a slower rate than national income, helping to contain demand pressures and inflationary risks. However, automatic stabilizers alone may not be sufficient to fully cushion the economic cycle. Their intensity or responsiveness may not be adequate to guarantee stable economic growth.
Automatic vs. Discretionary Fiscal Policy
It’s crucial to remember that stabilization policy aims for internal balance (non-inflationary growth of output and employment), not necessarily budget balance. The budget is a tool to achieve this goal. Sometimes, a deficit or surplus is necessary, while at other times, a balanced budget is desirable.
- Cyclical Deficit: This is the estimated deficit derived from comparing the actual economic growth path with the growth path that would correspond to internal balance.
- Discretionary or Structural Deficit: This deficit results from discretionary income and expenditure policies that would correspond to a situation of internal balance.