Optimal Aggregate Consumption for Economic Growth

Abstract

The Keynesian intuition that increasing consumption can stimulate investment is verified empirically using US macroeconomic data. The investment multiplier is hypothesized to increase monotonically with the propensity to consume. However, the functional relationship is not that of the Keynesian multiplier, as assumed axiomatically but incorrectly, in standard Keynesian economics. By modelling the investment multiplier as a power function of the consumption propensity, with empirically estimated parameters, we show that there exists an optimal level of aggregate consumption which maximizes national economic growth by balancing aggregate demand and supply in a dynamic equilibrium. For the US economy, the optimal aggregate consumption is estimated to be about 88 percent of the gross domestic product (GDP) over the data period. With the US aggregate consumption propensity already well past the optimal level in recent decades, US government policies to stimulate more consumption to increase economic growth have been counter-productive for several decades.