How to Grow the Economy

If the government wants to expand the economy, it could go about doing it multiple ways. It could cut taxes, so that consumers have more money in their pockets. The government can also send money to people in the form of checks as transfer payments. Both of these can be good politics as they can be spun to show that the government is trying to shrink itself and to not spend the people’s money wildly. Both of these can trouble because of the marginal propensity to spend. If people save that new money instead of going out to the store and spending it, that money is wasted in terms of trying to grow the economy. Money not spent does not show up in the GDP calculation (Krugman & Wells p. 386).

            However, there is a more effective way to grow the economy. If the government instead spends the money on good and services, the same money is out in the economy. There is still the fact that the money will get pushed on through to consumers, who will then spend only a fraction of that money and the government has to be cognizant of the marginal propensity to consume. Growing the size of the GDP directly through growing the G section of the GDP equation is much stronger than just giving people money. Not only does the government get money out into the economy, but the nation also gets a new bridge or jet fighter or whatever it is the government bought.

There are bound to be limits to this sort of growth.  For example, there is a lag time to new acquisitions. When the stimulus package was passed in the wake of the economic crisis of 2008, many of the infrastructure projects took time to get off the ground and there was much political hay made over the idea of “shovel ready projects”. Just sending checks to people is much faster, but then there are fewer jet fighters or state-of-the-art bridges. Overall, the lag time is a fair trade off as long as the MPC is below one.

Finally, there is a further concern that there are only so many bridges that can be built or improved. Once the nation is in a post-scarcity gleaming futuristic utopia then the direct government expenditure approach might not be the most effective avenue for growth, but the nation is far from that point for now.