August 15, 2017

Advancing to the correct multiplier

Comment on Peter Cooper on ‘Short & Simple 16 ― The Expenditure Multiplier and Income Determination’


Peter Cooper states: “We have seen that total spending equals total income. It has been argued that it is spending that creates (or determines) income. This can be inferred from the observation that some spending can occur independently of income. Spending that occurs independently of income is called autonomous spending. … Examples of autonomous spending are: government spending; autonomous private consumption; private investment; exports.”

We have proven that the statement ‘total spending equals total income’ is false.#1 By consequence, the whole formal apparatus of MMT is defective. This, of course, affects also the multiplier.

The elementary version of the correct (objective, systemic, behavior-free, macrofounded) Employment Law is shown on Wikimedia AXEC62: #2

From this equation follows:
(i) An increase of the expenditure ratio ρE leads to higher employment L (the Greek letter ρ stands for ratio). An expenditure ratio ρE greater than 1 indicates credit expansion, a ratio ρE less than 1 indicates credit contraction.
(ii) Increasing investment expenditures I exert a positive influence on employment.
(iii) An increase in the factor cost ratio ρF≡W/PR leads to higher employment.

The complete Employment Law contains in addition profit distribution, the public sector, and foreign trade.

Item (i) and (ii) cover the familiar arguments about aggregate demand. The factor cost ratio ρF as defined in (iii) embodies the price mechanism.

The correct employment and income multiplier consists of TWO components, the expenditure ratio ρE and the factor cost ratio ρF.#3 The latter component is missing in the familiar approaches which leads to wrong policy prescriptions.

Egmont Kakarot-Handtke

#1 For the full-spectrum refutation of MMT see cross-references MMT
#2 Keynes’ Employment Function and the Gratuitous Phillips Curve Disaster
#3 For details of the big picture see cross-references Employment

Related 'It’s the price mechanism, stupid!' and 'Rethinking the multiplier' and 'Note on the employment multiplier' and 'The labor market and the consistent failure of 101-economics'.