The Rise of the Keynesian Multiplier Model: 1940-1960

The Keynes Multiplier Effect

In the 1940s and 1950s, economists explored the multiplier model, developing it in excruciating detail. It was expanded to include international effects, various types of government expenditure, and different types of individual spending. Terms such as the balanced budget multiplier became standard parts of economic terminology, and every economics student had to learn Keynes's model.

It is interesting to note that the model and the monetary and fiscal policies that were and are generally called Keynesian are not to be found in Keynes's book. There is not a single diagram in The General Theory, nor any discussion of the use of monetary and fiscal policy. How, then, did the multiplier model (done algebraically and geometrically) become the focal point of the macroeco­nomic debates of the 1950s? Part of the reason is that it seemed to provide a better description of current reality than did the alternatives. But other factors were also at work. The initial policy debates about the validity of Keynesian economics focused on fiscal policy (government deficits during the war had apparently pulled the Western world out of the Depression). Because the multiplier model nicely captured the effects of fiscal policy, it tended to become the Keynesian model. We suspect that sociological reasons also played a role in both the initial adoption and long-term acceptance of this model. The need for truth is often tempered by other needs of the profession—specifically, teaching requirements and the necessity of publishing journal articles. The multiplier model fit those needs beautifully.

It was in the United States that the multiplier analysis caught on. Paul Samuelson and Alvin Hansen (1887-1975) developed it into the primary Keynes­ian model. Samuelson's textbook introduced it into pedagogy, other books copied Samuelson's, and soon the multiplier model was Keynesian economics. The multiplier analysis had many pedagogical advantages, being easy to teach and learn. It allowed macroeconomics to develop as a separate field by providing a core analytical structure for the course, just as supply-and-demand analysis had for microeconomics.

The Depression of the 1930s had changed the context within which society and economists viewed the market. Prior to that time, the neoclassical arguments in favor of laissez faire had been based not only on economic theory but also on a set of philosophical and political judgments about government. The general political orientation of almost all individuals except radicals in the early 1900s was against major government involvement in the economy. Within that context, the concepts of many government programs that we now take for granted, such as Social Security and unemployment insurance, would have seemed extreme.

With the onset of the Depression, attitudes began to change. Many people felt that if the free market could lead to such economic distress as existed during the Depression, it was time to start considering alternatives. As economists began to analyze the aggregate economy in greater detail, many became less confident of their policy prescriptions and much more aware of the shortcomings of neoclas­sical theory. Consequently, economists began to advocate a variety of policy proposals to address unemployment that were inconsistent with their main­stream neoclassical views. In the early 1930s, for example, A. C. Pigou in England and several University of Chicago economists in the United States advocated public works programs and deficits as a means of fighting unemployment.