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Wednesday, July 11, 2012

Rothbard's Critique of the Multiplier

Murray Rothbard never cared if an argument he offered was sound, but only about whether it seemed to make his opponent look stupid. Consider, for instance, his "reductio" of the Keynesian multiplier:
Social Income = Income of (insert name of any person, say the reader) + Income of everyone else.
Let us use symbols:

Social income = Y
Income of the Reader = R
Income of everyone else = V

We find that V is a completely stable function of Y. Plot the two on coordinates, and we find historical one-to-one correspondence between them. It is a tremendously stable function, far more stable than the “consumption function.” On the other hand, plot R against Y. Here we find, instead of perfect correlation, only the remotest of connections between the fluctuating income of the reader of these lines and the social income. Therefore, this reader’s income is the active, volatile, uncertain element in the social income, while everyone else’s income is passive, stable, determined by the social income.

Let us say the equation arrived at is: V = .99999 Y
Then, Y = .99999 Y + R
.00001 Y = R
Y = 100,000 R

This is the reader’s own personal multiplier, a far more powerful one than the investment multiplier. To increase social in- come and thereby cure depression and unemployment, it is only necessary for the government to print a certain number of dollars and give them to the reader of these lines. The reader’s spending will prime the pump of a 100,000-fold increase in the national income.
 -- Man, Economy, and State, p. 867-868
Of course, what has been ignored is the relationship of R to V. In the simplest version of the Keynesian multiplier story, an essential element is that C remains a constant percentage of Y (ignoring autonomous consumption) regardless of what happens to G or I. Therefore, an increase in G or I must lead to enough of an increase in C to keep that percentage where it was. Now, that may be an invalid assumption, but Keynesians have a story as to why we'd expect something like that to happen, and then they actually go and do empirical work to discover to what extent it really does happen.

But if we look at the relationship of R to V, we would expect to find that they vary inversely: If my income was .00001 Y and it doubled the next year, the income of everyone else simply dropped to .99998 Y. Rothbard has played a trick here: because V is such a huge percentage of Y, he can claim it is "a completely stable function of Y." But the correct thing to look at is: When R changes, does V respond so as to maintain its ratio to Y? While the Keynesian story may be wrong, at least it represents a theory as to why the ratio might be roughly constant. Rothbard, on the other hand, has absolutely no theory for positing that V and R are behave like they do in his model, and thus his example is hardly "in keeping with the Keynesian method."

The correct answer for the multiplier in Rothbard's example is roughly 1 rather than 100,000. Rather a bad error. But who cares? For readers who did not bother to analyze the example carefully, it sure made the Keynesians look dumb!

2 comments:

  1. If you ever knew Rothbard personally, did you ever critique his arguments to him?

    His argument here is strange - an unlikely multiplier leads to an unlikely increase in income? As if it should be some other way round?

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  2. That book had quite a few blunders, I thought, too.

    I especially like how he goes on for hundreds of pages about how utilities can't be quantified and interpersonal utilities can't be compared, and then claims that free markets maximize social utility.

    Huh?! How'd that get past the editor?

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