Multiple Problems December 6, 2008

Posted by A Texan In Grad School in Economic Theories, Federal Debt.

Here’s an interesting question on trade and Keynesian fiscal policy inspired by a post by Dani Rodrik:

The Keynesian multiplier is:

$\frac{1}{1-c(1-t)+m}$

where c is the marginal propesnity to consume, t is the tax rate, and m is the marginal propensity to import.  It is clear from this formula that m is inversely proportional to the multiplier.  So, if we decrease m, we will maximize the multiplier, in terms of m.  Therefore, raising import tariffs such that m=0 will give us high growth and employment for the same amount of government spending.  Also we eliminate our current account deficit.  Seems good all around…

Now, how can this be square with Ricardian theories of comparative advantage?  How can eliminating trade actually increase economic growth?