The Keynesian multiplier theory suggests that spending generates more spending, benefiting the economy as a whole. However, its validity is disputed by some economists who argue that it makes false assumptions about economic behavior. An example of the theory in action is a manufacturer injecting $100,000 into a local economy, with the multiplier effect predicting an increase in economic activity beyond the original amount.
The Keynesian multiplier is an economic theory that states that spending generates more spending, to the benefit of the economy as a whole. The theory was proposed by the economist Richard Kahn in the 1930s, as an integral component of John Maynard Keynes’s larger work, The General Theory of Employment, Interest and Money. Modern economists are far from united in the validity of Kahn’s or Keynes’s work. The Keynesian multiplier and the whole Keynesian approach are widely dismissed as remnants of discredited central economic planning by governments. However, its influence persists among some economists and economic schools of thought.
An example of how the Keynesian multiplier is supposed to work might be a manufacturer moving to a new community and injecting US$100,000 into the local economy by purchasing goods from local merchants. If this new company spends $40,000 with Company A, $35,000 with Company B, and $25,000 with Company C, the multiplier effect predicts that Companies A, B, and C will spend a certain percentage of their new revenue with three more companies, which will also spend part of its new income. If each company spends half of its new revenue, aggregate economic activity would increase by total spending. In this example, the increase in activity is the original $100,000, plus $20,000 for Company A, plus $17,500 for Company B, plus $12,500 for Company C. The point of the Keynesian multiplier is that economic activity is not increased simply by the original $100,000 USD but by an increasing total, which is $150,000 USD more in this example.
Economic critics disagree for several reasons. The gist of his criticisms is that the Keynesian multiplier makes assumptions about economic behavior that are demonstrably false. If, for example, spending actually multiplies economic activity, then a spending injection of only a limited amount could generate an unlimited increase in activity, like a perpetual motion economic machine. Instead, empirical studies have produced multiplier effects of less than 1, suggesting that instead of multiplying or even increasing spending, centralized spending injections crowd out other economic activities.
As a perhaps exaggerated example of his belief in the multiplier effect, Keynes suggested that governments could simply bury the coin in the ground and lease the right to dig it up. The result would be full employment and capital appreciation. His detractors consider any non-productive activity completely wrong.
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