Magic Multiplier Theory

Veronique de Rugy discusses When Puff the Magic Multiplier Goes Poof.

The belief is that when the government takes a dollar out of your pocket, puts that dollar through the political process and decides where to spend it (based on input from special interest groups), the economy will somehow return more money in growth than the money invested, even after Washington bureaucrats take their cut. It's magic! Sadly, these arguments ignore recent empirical evidence that the costs of increased government spending far outweigh the benefits to the economy.

After reviewing the recent academic literature for the Mercatus Center's publication The Bridge, my colleague Jack Salmon and I found that most of "the empirical literature on fiscal multipliers conducted since then (2009) has found economic multipliers resulting from additional government spending ranging from a lower estimate of around 0.2 to an upper estimate of around 0.9." We go on to explain that in "(p)ulling the results from two dozen academic studies, we calculate an average multiplier at the low end of 0.31 and an average multiplier at the high end of 0.66."

There are always economists, journalists and pundits willing to assume that this time will be different and government spending will deliver on the promises made on its behalf by pro-spending advocates. Unfortunately, this is wishful thinking. It is also a dangerous game to play. If spending doesn't deliver on the promised economic growth, what it will undoubtedly achieve is more debt. That, sadly, is a scenario where future growth goes up in a puff of smoke.

No Magic Multiplier, Only Debt

The headline title is a bit misleading. It sounds as if there is a multiplier about to go poof.

There is a temporary demand shift forward but at a huge cost.

Long-term, the multiplier is negative for many reasons.

Negative Multiplier Due To:

  1. Increased long-term debt.
  2. Zombification of unproductive companies at the expense of healthy ones.
  3. Taking money from productive segments of the economy to relocate them to segments performing poorly is poor policy. 
  4. Government can never allocate money wisely. Only the free market can. 

Let's not confuse the alleged short-term benefit of .31 to .66 (assuming it happens at all), with magic.

Ho, Ho, Ho!

Ho, Ho, Ho, It's NOT Magic. It's just foolish. Debt and deficits are proof.


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