Sunday, August 28, 2011

Lecture 10. STIMULUS ON STEROIDS


The MPC Effect

In the assumptions we made in the previous lecture, we did not explain the significance of the word “shortly”. In economic theory, time is of the essence. If Jane and all her friends were to reduce movie attendance from once a week to once a month, Hollywood would suffer. The MPC explains much of the difference between prosperity and depression. Indeed, Keynes considered “hoarding” of cash to be the cause of recessions. The very rich may not change their spending habits much during a recession, but the rest of us begin to save at an unusually high rate. That has an immediate effect on industries dependent upon discretionary spending: stocks and bonds, real estate, autos, electronics, home furnishings, clothing, restaurants, sports, entertainment, and even food on the table. And that starts the downward spiral. The key to increasing the value of the multiplier and the efficacy of a stimulus and the growth of the GDP is to increase the MPC. In the previous lecture, in Assumption (2), we set the value of MPC at 90%. The resulting value of the multiplier was 2.45. If we give MPC the value 100% = 1,0, recalculation of the multiplier would (using data from Assumption 1, Lecture 8) proceed as follows: Cp = MPC × (1 - Ct) = 1.0 × (1 - 0.3) = 1.0 × 0.7 = 0.7 Pc × Cp = 0.47 × 0.7 = 0.329 (1)) M = 1 + {(Pc × Cp) / [(1 − Pp) - (Pc × Cp)]} = 1 + {0.329 / [(1 − 0.5) - 0.329]} = 1 + (0.329 / 0.171) = 1 + 1.924 = 2.92 An 11% MPC increase produced a 19% increase in the multiplier value. This lends credence to the importance of the MPC. To study the question further, let's do some accounting to show the effect of the MPC increase.

An MPC Experiment



Using mid-year 2011 approximate results from usdebtclock.org: Pre-stimulus ND: $14.5T Pre-stimulus GDP: $14.8T Pre-stimulus DR: 98.0% Stimulus: $ 1.0T Tax burden* / GDP = 0.3 *for all levels of government

Then for MPC = 90%:

Multiplier = 2.45 GDP growth, ΔGDP = M x S / 5 = 2.45 x $1T / 5 = $0.490T Tax revenue gain, ΔTR = ΔGDP x TB × 5 = $0.490T x 0.3 × 5 = $0.735T Infrastructure purchase discount, IPD = ΔTR / S = $0.735T / $1T = 73.5% New ND = ND + S - ΔTR = $14.5T + $1.0T - $0.735T = $14.765T New GDP = GDP + ΔGDP = $14.8T + $0.490T = $15.290T New DR = New ND / New GDP = $14.765T / $15.290T = 96.56% DR change, ΔDR = New DR - DR = 96.56% - 98.0% = -1.44%

Now, let’s raise MPC to 100%

Multiplier = 2.92 GDP growth, ΔGDP = M x S / 5 = 2.92 x $1T / 5 = $0.584T Tax revenue gain, ΔTR = ΔGDP x TB × 5 = $0.584T x 0.3 × 5 = $0.876T Infrastructure purchase discount, IPD = ΔTR / S = $0.876T / $1T = 87.6% New ND = ND + S - ΔTR = $14.5T + $1.0T - $0.876T = $14.624T New GDP = GDP + ΔGDP = $14.8T + $0.584T = $15.384T New DR = New ND / New GDP = $14.624T / $15.384T = 95.0% DR change, = ΔDR = New DR - DR = 95.0% - 98.0% = -3.0%

To contrast the change induced by raising MPC:
EFFECT OF MPC ON IPD and ΔDR
MPC MULTIPLIER DISCOUNT DR DROP
90% 2.45 73.5% 1.44%
100% 2.92 87.6% 3.0%

Maximize the Marginal Propensity to Consume

The effect is striking. If we accept the previous lecture's model and assumptions and as long as there are idle resources, we can reduce the DR by building infrastructure! In any case, the larger the multiplier, the larger the purchase discount. But can we realistically set the effective value of MPC equal to 100%? People do indeed save money, sometimes more 10% of their disposable income. And the recession guarantees a high saving rate. Q: Where do people save their money? A: In banks. Q: What do banks do with their assets? A: To increase income, they lend as much of it as possible as soon as possible. Q: What do borrowers do with their loans? A: To reduce interest cost and begin reaping gains from their venture, they invest it as soon as possible. Q: Can the effective MPC conceivably approach 100%? A: Yes, if enough entrepreneurs have profitable ventures in mind and banks are able to grant the loans judiciously. Q: Can that happen in a recession? A: Yes, if enough of the entrepreneurs have federal government contracts in hand when applying for the loan. Q: How soon could that happen? A: As soon as Congress passes and the President signs a stimulus bill large enough to give overtime work to all of our unemployed and under-empoyed. And that happened during WW II, as the historical evidence in a future lecture will show. Q: How much can banks lend. A: With our fractional reserve system, banks can lend up to a multiple of their reserves. The multiple has a value at least 10 and often 20, depending upon the policies of management. Q: What is the effect of a stimulus upon bank reserves and bank funds available for loans? A: With Marginal Propensity to Save (MPS) = 10% of disposable income and Marginal Propensity to Consume (MPC) = 90% of disposable income and Total Consumer Spending / Stimulus = 1.45, (from the previous lecture) hence: Total Consumer Saving / Stimulus = 10% / 90% = 0.16 and $1T of stimulus could add $0.16T to reserves. With a minimum multiple of 10, $1T of stimulus could add $1.6T of funds available for loans and creditworthy loan applications may be funded. Q: What is the effect of stimulus on loan applications? A: A large stimulus could increase consumer confidence and improve business sentiment toward investment. If a stimulus increased private investment by more than 10% of the value of the stimulus, the multiplier would effectively increase by more than 10%. A multiplier approaching 3.0 (as shown above) would approach 3.3. Q: With a multiplier approaching 3.3, what is the effect of infrastructure cost upon the federal deficit? A: With Infrastructure Purchase Discount (IPD) = Multiplier x Tax Burden = 3.3 x 30% = 99%, the effect of infrastructure cost upon the federal budget deficit In any case, the larger the multiplier, the larger the purchase discount. But can we realistically set the effective value of MPC equal to 100%? People do indeed save money, sometimes more 10% of their disposable income. And the recession guarantees a high saving rate. Q: Where do people save their money? A: In banks. Q: What do banks do with their assets? A: To increase income, they lend as much of it as possible as soon as possible. Q: What do borrowers do with their loans? A: To reduce interest cost and begin reaping gains from their venture, they invest it as soon as possible. Q: Can the effective MPC conceivably approach 100%? A: Yes, if enough entrepreneurs have profitable ventures in mind and banks are able to grant the loans judiciously. Q: Can that happen in a recession? A: Yes, if enough of the entrepreneurs have federal government contracts in hand when applying for the loan. Q: How soon could that happen? A: As soon as Congress passes and the President signs a stimulus bill large enough to give overtime work to all of our unemployed and under-empoyed. And that happened during WW II, as the historical evidence in a future lecture will show. Q: How much can banks lend. A: With our fractional reserve system, banks can lend up to a multiple of their reserves. The multiple has a value at least 10 and often 20, depending upon the policies of management. Q: What is the effect of a stimulus upon bank reserves and bank funds available for loans? A: With Marginal Propensity to Save (MPS) = 10% of disposable income and Marginal Propensity to Consume (MPC) = 90% of disposable income and Total Consumer Spending / Stimulus = 1.45, (from the previous lecture) hence: Total Consumer Saving / Stimulus = 10% / 90% = 0.16 and $1T of stimulus could add $0.16T to reserves. With a minimum multiple of 10, $1T of stimulus could add $1.6T of funds available for loans and creditworthy loan applications may be funded. Q: What is the effect of stimulus on loan applications? A: A large stimulus could increase consumer confidence and improve business sentiment toward investment. If a stimulus increased private investment by more than 10% of the value of the stimulus, the multiplier would effectively increase by more than 10%. A multiplier approaching 3.0 (as shown above) would approach 3.3. Q: With a multiplier approaching 3.3, what is the effect of infrastructure cost upon the federal budget? A: With Infrastructure Purchase Discount (IPD) = Multiplier x Tax Burden = 3.3 x 30% = 99%, the net addition of infrastructure appropriations to the federal budget approaches zero! During a recession, with IPD approaching 100%, a sufficiently generous stimulus would bring full employment; increase tax revenue; lower the DR; and repair, rebuild, and renew our infrastructure at almost zero net deficit.

Proceed to: Lecture 11. INDEBTEDNESS: THE STIMULUS EFFECT


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