New Evidence Challenges Keynesianism and Modern Monetary Theory

Many governments and central banks rely on Keynesianism to justify their expansionary policies either by increasing government expenditures directly or increasing credit growth, with a hypothesis that the expansionary policies can boost economic growth.

For example, Policonomics (2017) explains Keynesianism as follows: “Supporters of Keynesianism believe that although businesses and private sector entities working on a liberal environment function in an efficient way, sometimes market failures may appear. For this, they support a certain degree of implication by the public sector in order to prevent these failures and restore the economy if they appear, through fiscal and monetary policies.”

However, there are more and more studies refuting or challenging the Keynesianism hypothesis. One of the earliest contentions was Mitchell (2005) which concluded that “ a large and growing government is not conducive to better economic performance.”

Then, Cogan, Cwik, Taylor and Wieland (2009) found that “all of the multipliers are less than one, meaning that for every dollar of ‘stimulus’ spending, the number of goods and services produced by the private sector declines. For example, the multiplier effect of the Obama stimulus program was 0.96 in the early stages, but falling rapidly to 0.67 by the end of 2009 and to 0.48 by the end of 2010. Their study showed that, by 2011, for each stimulus dollar spent, private sector output would fall by almost 60 cents.” (cited in Rickards, 2011)

Furthermore, Thabane and Lebina (2016) also found empirically that the cause and effect are in fact reversed. That is, it is economic growth that causes government expenditure growth, instead of what Keynesianism suggests that government expenditure growth causes economic growth.

Thus, the Keynesianism hypothesis of the effect of fiscal expansion on economic growth can be regarded as being refuted. Yet, there have been very few empirical studies on the monetary expansion hypothesis so far, especially when it is recoined as Modern Monetary Theory (MMT) theory.

MMT theorists contend that governments “can sustain much greater deficits without cause for concern”, and argue otherwise that “a small deficit or surplus can be extremely harmful and cause a recession since deficit spending is what builds people’s savings.” (Dsouza, 2019)

However, a recent study about China found that the effect of credit growth policy on economic growth has a diminishing multiplier effect. Chen, Ratnovski and Tsai (2019) found that the credit multiplier dropped from 0.2 to close to 0 from 2001–2008 to 2010–2015 period in China. It is explained by credit saturation and credit misallocation. They concluded that “credit expansion cannot further support economic growth in China.” Yet, the same study found that the fiscal multiplier increased from 0.7 to 1.2 in the same period.

The author defined Credit Multiplier as the “two-year growth in real credit and expenditure relative to two-year lagged GDP” of provinces and explained why there were so few empirical studies on the effect of Credit Multiplier on economic growth. It is the cause and effect logic again as found in Thabane and Lebina (2016). “Credit is endogenous because credit demand and possibly credit supply are pro-cyclical, an empirical identification of the multiplier, therefore, requires policy shocks that are exogenous to macroeconomic conditions.”

Interestingly, the authors found that due to the appointment and appraisal system of government officials in province level would impose such policy shocks that are exogenous to macroeconomic conditions, and becomes a unique testing sample for the hypothesis.

“The tenure of provincial party secretaries is a source of exogenous variation in credit and fiscal expenditure in Chinese provinces. … The timings of the appointments (and reappointments) of provincial party secretaries are largely determined by the tenure of the previous secretary and the national political cycle. Consequently, they are unrelated to local economic conditions. Moreover, provincial party secretaries have incentives to use stimulus policies at strategically important times during their tenure to improve the prospect of their retention or promotion.”

They tested the hypothesis by a panel regression model of 31 provinces in China with the fixed effects of macroeconomic and national policies being controlled, as follows:

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Figure 1 Panel Regression Model for testing the Credit Multiplier Effect on Economic Growth. Source: Chen et al., 2019

One of the empirical results shows that credit growth would be saturated and its effect on economic growth is reduced to close to zero after pumping RMB4000 billion after the Global Financial Crisis in 2008 and further quantitative easing policies afterwards.

Figure 2 Results of the Panel Regression. Source: Chen et al. (2019)

The impact of real credit is 0.215% on real GDP in 2001–2008 period, but then its effect is reduced to insignificant in 2010–2015 period. It is posited that too much credit would have a diminishing effect on GDP (credit saturation) and more and more credit is misallocated. However, this is just a weak form test as the impact in 2010–2015 period is insignificant, rather than a significant but negative effect. There can be other biases that result in insignificant results.


Chen, S. and Ratnovski, L. and Tsai, P.H. (2019) Credit and Fiscal Multipliers in China. BOFIT Discussion Paper #5/2019. SSRN:

Cogan, J.F., Cwik, T., Taylor, J.B., Wieland, V. (2009) New Keynesian versus Old Keynesian Government Spending Multipliers,

Dsouza, D. (2019) Modern Monetary Theory (MMT), Investopedia, Feb, 28.

Mitchell, D.J. (2005) The Impact of Government Spending on Economic Growth, The Heritage Foundation,

Policonomics (2017) Keynesianism.

Rickards, J. (2011) Currency Wars: The Making of the Next Global Crisis, New York: Penguin.

Thabane, K. and Lebina, S. (2016) Economic Growth and Government Spending Nexus: Empirical Evidence from Lesotho, African Journal of Economic Review 4(1), 86–100.

ecyY is the Founder of Real Estate Development and Building Research & Information Centre REDBRIC

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