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
Thanks for your interest.
Marvin Sussman, retired engineer
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