Read this article to learn about the dynamic and static concept of the multiplier in an economy.
Criticism has been levied on Keynes’ theory of investment multiplier on the ground that it is a static formulation and it has no connection with the dynamic process of income generation.
It does not tell us what happens in between the initial increase in investment and the final increase in income.
We have no means to know how and in what stages or time intervals the final increase in the total income is attained. Keynesian multiplier shows the process of income expansion from one point of equilibrium and that too under static assumptions. No idea is given of the actual sequence of events and no time- lags are involved.
The whole process of income propagation is automatic, unhampered by time or other factors. For example, it may be remembered that multiplier does not work only when changes in the expenditures occur as a result of private and public investment, but also due to increases in consumption expenditures (though Keynes assumed them to be stable in the short-run).
Should the investment expenditures remain fixed over time a decline in savings or a reduction in taxes may lead to increased consumption expenditures in the long-run giving rise to multiplier effects. Post-Keynesian writers have pointed out that the magnitude of the multiplier is bound to be affected by time lags, i.e., by the fact that the particular doses of investments will take time to exert their full influence in raising income.
Meanwhile, it is just possible that fresh investments may have taken place and may themselves cause multiplier effects. If there are time lags, the final equilibrium position will take longer to reach, the income rises more slowly than it would do in the absence of lag. Keynes seems to have thought that the effects of such lags would be unimportant. But the real multiplier, should take into consideration the dynamic forces working in the economy.
According to the critics, it is better to replace the Keynesian static multiplier by the dynamic multiplier, which takes account of changing events. Despite these observations, it is useful to remember that Keynes discussed, though briefly, three different concepts of the multiplier: the logical theory of the multiplier assuming no time lag, the period analysis concept of multiplier based on the assumption of time lags and ‘comparative statics’ timeless concept of multiplier in which the transition process or the path is skipped over completely.
The discussion still continues. On the one hand, there were and still are, some points which require clarification, on the other hand, the highly simplified models of Johannsen, Kahn and Keynes require modifications and extension in certain directions. We should like to take up two of the many directions with which current research is concerned.
These are as follows:
The first direction relates to the time it takes for the multiplier process to work itself out. We speak of the multiplier effects in the first, second, third etc. period (specially in case of dynamic multiplier) and note that after a small number of periods the size of the effects is very near the final equilibrium value. Thus, we still have to know how long these periods are, whether they last a day, a week, a month or a year.
Johannsen felt that the interval between cause and effect was not very long; rather cause and effect proceed together hand in hand. It is possible and even probable that his conjecture is correct. Yet to get a correct answer, lot of empirical work and research is required. Attempts to answer these questions were made by F. Machlup’ and more recently by G. Ackley.
Thus, the pure theory of multiplier shows the definitional relation between the ‘propensity to consume’ and the ‘multiplier’. Many problems which frequently arise under the heading ‘multiplier’ lie outside the pure theory of the multiplier. Apart from the problems mentioned above, other problems relate to the determination of the amount of net investment associated with a given amount of spending under varying circumstances and the determination of the numerical value of the multiplier.
The MPC of the individual to which Keynes fundamental psychological law refers, is only one of many factors which are casually important for the determination of the MPS (multiplier) of society as a whole. Hence, we need not exaggerate the stability of the multiplier over time.