Common Sense and the Balanced Budget

What this shows is that a balanced budget does not mean a balanced economy!! There is a balanced budget multiplier, and in this simple model, it is exactly one -- meaning that one more dollar of spending and taxation will increase equilibrium income by -- one dollar.

I have suggested that this is against common sense, but it is always hard to be certain about that. One person's "common sense" may say one thing, and another person's "common sense" may say another -- as the saying goes, common sense isn't really all that common!

What is common sense? My answer is that common sense is cheap theory. Common sense is the kind of theory we can get from cab drivers and bartenders, and we don't have to make much effort to understand or use it. So it doesn't cost us much, either for tuition or effort. Cheap theory.

And there is nothing wrong with that. Any economist will say that the price is right -- if cheap theory does the job, go with it!

But the balanced budget multiplier is a good example of how common sense often doesn't do the job. Common sense is worth at least what you pay for it -- nothing. Maybe a little more. But it often makes better "common sense" to make the effort to learn a more reliable kind of theory, and to study fields like economics and mathematics. As it happens, the discovery of the balanced budget multiplier came from mathematics, not economics.

Mathematical Economics in Action

The balanced budget multiplier was discovered by Trygve Haavelmo, a Norwegian economist. Haavelmo was putting Keynesian economics into the form of a mathematical model as a step toward statistical testing of the theory, and the discovery of the balanced budget multiplier came as a surprise to him and everybody. This illustrates how, in economics as in some other fields, mathematics can be a "language of discovery." Haavelmo got the Nobel Memorial Prize in Economics for this discovery, among others, 40 years later.

Gaps and Prescriptions