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What is The Economic Multiplier?

Yet another in our ongoing series of Economic rambling that seeks to explain some of the academic arguments about the economy, mix in my cloudy memory of theory, and just try to say enough stupid shite to start a discussion.

One of the concepts that economic policy is based on is The Multiplier – the idea that if you pump money into the economy you get a lift from that cash, but there’s also a multiplier effect. $250 Billion goes to bail out the auto industry, but a huge chunk of this ends up being the salary of the UAW guys building the cars. In our simple model the good news is that these guys, like most good Americans, don’t bother to save one red cent (in fact, they carry credit card debt, spending beyond their means). As a result that $250 B gives the economy a second jolt – if it all rolls through you get a multiplier of 2 there, but it doesn’t stop yet hulkamaniacs, our UAW guys bought dinner at the local restaurants and so the restaurant owners and waitstaff have some extra cash to throw around, not the full $250B, just a portion – $20B, add in the bar tab, maybe $240B. Just kidding. Lets make it $25B because I’ve forgotten all real econometrics. We’re up to a $525B, or a 2.1 multiplier.

For some reason I recall that the Fed considers 4 to be about right, of course maybe my memory is terrible (I think it is but I can’t really recall), or that could be some policy wonk pulling a stat out of their keister. The problem is that trying to measure it is extraordinarily difficult and then there’s also the problem of inflation – in an economy where nobody saves, in theory it would touch everyone and you’ve done nothing but devalue the dollar. There’s also the issue of that money leaving the shores of the US and going to other countries who are not on an even trade balance with us.

So we reach a question – will the current crisis change the average American’s propensity to save, thus reducing a multiplier effect? Or will they say “Screw it, Rolexes have never been cheaper, I’m rollin’ R. Kelly style.” I have no idea, but I do know that the multiplier is a theory that the government needs us to believe to assure us that government can affect the course of the economy. I’ve never seen the multiplier used to show the damage done by a reduction in spending, maybe that was about the time the Spring Concerts were rolling at UMass, but you can use the same theory there. Ultimately big shocks create smaller waves that can encourage additional big shocks, until there’s nothing left to be lost in the markets that are dying – either by complete collapse, or being artificially propped up until the shocks subside. Other industries will be impervious to the downturn, and indeed others will thrive.

The marketing message – pay no attention to the man behind the curtain. Continue to innovate and deliver value, and pray that we hit the bottom before the infrastructure begins to crack.