The failure of economics in the runup to and aftermath of the Great Recession has generated a lively debate about how to reform economics and more specifically about the renewed relevance of Keynesian economics, which had fallen out of favor since the 1970s. The Keynesian message, so important in this latest round of political wrangling over the increase in the US debt ceiling, is that cutting government spending in a slump will only worsen the unemployment problem. The role of expansionary fiscal policy, according to Keynesianism 101, is to provide demand for goods (and thus for employees to produce those goods) when the main sources of demand in a capitalist economy — households and businesses – are not providing a level of demand necessary to generate a socially acceptable level of unemployment.
Keynesianism 102 is about the multiplier effect of changes in spending. This is the notion that an increase in demand (from any source, not just government but certainly including government) will impact employment and incomes with a ripple effect. This includes a direct impact and then a secondary impact when the direct incomes are then spent (in some fraction) and an additional fraction of that is spent, etc.
There are two corollaries to the lesson of Keynesianism 102 that are worth mentioning because they have been raised in the current policy debate. The first is about the differential multiplier effect of a spending increase compared to a tax cut. Empirical studies show that the multiplier effect of the former is greater than the multiplier effect of the latter. The second is about the differential multiplier effect depending on the income of the recipients. Since the poor are more likely to spend a higher percentage of additional disposable income than the rich, a tax cut that benefits low-income people will have a bigger multiplier effect than a tax cut that benefits the rich.
These lessons have not been integrated into current economic policy in the US, where deficit spending and progressive tax reform and expanded benefits for . . .
Read more: Unemployment Equilibrium: Keynesianism 103