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Which of the following is most likely to reduce the size of the multiplier in the simple (2-sector) Keynesian model?

  1. Increased taxes on savings
  2. Reduced access to government funded medical care
  3. Reduced compulsory superannuation contributions for workers
  4. Increased competition in the banking sector, leading to lower borrowing costs

Answer given by the lecturer was 2. Could some please explain why? I thought that it was 3 (Employees have to save more of their earned income for retirement because firms no longer supplement super contributions for their workers, which increases the marginal propensity to save and decreases the multiplier.) How could it be 2 if we are in the two-sector Keynesian model? Doesn't that condition imply that there is no government spending to begin with as we are only considering the interaction between households and firms?

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  • $\begingroup$ Having a government intervene in two-sector is common practice, see ideas.repec.org/a/mcb/jmoncb/v27y1995i1p232-56.html $\endgroup$ – VicAche May 27 '15 at 11:23
  • $\begingroup$ Thanks for that. Is there a reason why 3 is incorrect? $\endgroup$ – Socialise May 27 '15 at 12:33
  • $\begingroup$ those questions are tricky, you've got a lot of unsaid magic so I would agree with the lecturer until I get the time to look at it coldly :P $\endgroup$ – VicAche May 27 '15 at 12:36
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    $\begingroup$ Superannuation funds are actually never dormant, they're given back to retired people and/or invested, so I would guess 3 has little impact $\endgroup$ – VicAche May 27 '15 at 12:38
  • $\begingroup$ Okay my lecturer helped clear this up. Compulsory superannuation raises national savings by forcing workers to save - when workers aren't made to put away a proportion of their income as savings, they are able to spend some of the money that would have otherwise been saved, decreasing the MPS and increasing the MPC, which reduces the multiplier. $\endgroup$ – Socialise May 29 '15 at 12:40

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