The macroeconomy
John Maynard Keynes (1883–1946)
1931 British economist Richard Kahn sets out an explicit theory to explain the multiplying effects of government spending suggested by John Maynard Keynes.
1971 Polish economist Michal Kalecki further develops the notion of the multiplier.
1974 US economist Robert Barro revives the idea of “Ricardian equivalence” (that people alter their behavior to adjust to government budget shifts). This implies there are no multiplier effects from government spending.
Macroeconomics seeks to explain the working of entire economies. In 1758, the French economist François Quesnay demonstrated how large amounts of spending by those at the top of the economic tree—the landlords—was multiplied as others received money from them and re-spent it.
In the 20th century British economist John Maynard Keynes looked specifically at why prices and labor do not revert to equilibrium, or natural levels, during depressions. Classical economics—the standard school of thought from the 18th to the 20th centuries—says that this should naturally occur through the normal working of the free market. Keynes concluded that the fastest way to help an economy recover was to boost demand through an increase in short-term government spending.
"Besides the primary employment created by the initial public works expenditures, there would be additional indirect employment."
Don Patinkin
US economist (1922–95)
A key idea here was that of the multiplier, discussed by Keynes and others, notably Richard Kahn, and then developed mathematically by John Hicks. This says that if a government invests in large projects (such as road building) during a recession, employment will rise by more than the number of workers employed directly. National income will be boosted by more than the amount of government spending.
This is because workers on the government projects will spend a portion of their income on things made by other people around them, and this spending creates further employment. These newly employed workers will also spend some of their income, creating yet more employment. This process will continue, but the effect will lessen on each round of spending, since each time some of the extra income will be saved or spent on goods from abroad. A standard estimate is that every $1 of government spending might create an increase in income of $1.40 through these secondary effects.
In 1936, British economist John Hicks devised a mathematical model based on the Keynesian multiplier, known as the ISLM model (Investment, Savings, the demand for Liquidity, and the Money supply). It could be used to predict how changes in government spending or taxation would impact on the level of employment through the multiplier. During the post-war period it became the standard tool for explaining the working of the economy.
Some economists have attacked the principle of the Keynesian multiplier, claiming that governments would finance spending through taxation or debt. Tax would take money out of the economy and create the opposite effect to that desired, while debt would cause inflation, lessening the purchasing power of those vital wages.
Vast infrastructure projects, such as the Three Gorges Dam, China, can create thousands of jobs. The new workers’ wages then pour back into the economy, creating a second round of spending.
The son of a journalist, John Hicks was born in Warwick, England, in 1904. He received a private-school education and a degree in philosophy, politics, and economics from Oxford University, all funded by mathematical scholarships. In 1923, he began lecturing at the London School of Economics alongside Friedrich Hayek and Ursula Webb, an eminent British economist who became his wife in 1935. Hicks later taught at the universities of Cambridge, Manchester, and Oxford. Humanitarianism lay at the heart of all his work, and he and his wife traveled widely after World War II, advising many newly independent countries on their financial structures. Hicks was awarded the Nobel Prize in 1972. He died in 1989.
1937 Mr. Keynes and the Classics
1939 Value and Capital
1965 Capital and Growth