In teaching Advanced Placement Macroeconomics and International Baccalaureate Higher Level Economics, a key topic is the government spending multiplier, a major component of Keynesian economic theory. The idea is that a dollar of government spending will increase the country’s gross domestic product by more than a dollar. In other words, government spending’s effect on the economy is “multiplied” as the spending translates into someone else’s income which gets spent and so on. This is taken as gospel among the economics textbooks, and we spend a lot of class time explaining and teaching formulas without ever questioning if it’s true.
For the most part, it appears that a rise in government spending does not stimulate private spending; most estimates suggest that it significantly lowers private spending. These results imply that the government spending multiplier is below unity. Adjusting the implied multiplier for increases in tax rates has only a small effect. The results imply a multiplier on total GDP of around 0.5.
What this means is that every additional dollar of government spending on “stimulus” only increases the country’s GDP by 50 cents.
So do I teach the theory they need to answer a test question, or do I teach the truth?