Multiplier Effect
The amplified impact of an initial change in spending on total economic output.
What is Multiplier Effect?
The multiplier effect describes how an initial change in spending — by government, business, or consumers — generates a larger total change in economic output (GDP). When a government spends $1 on infrastructure, for example, the construction workers earn income, spend part of it on goods and services, whose sellers then spend part of their income, and so on. Each round of spending adds to GDP. The fiscal multiplier is the ratio of the total GDP change to the initial spending change. Multipliers are larger when the marginal propensity to consume is high, when the economy has spare capacity (high unemployment), and when monetary policy is accommodative (low interest rates). The concept was developed by John Maynard Keynes.
Example
The IMF estimated that fiscal multipliers during the 2008–2009 global financial crisis were significantly higher than prior estimates — between 0.9 and 1.7 for advanced economies — because central banks had cut rates to zero and economies had large output gaps. Government spending of $1 billion was found to add $900M–$1.7B to GDP in those conditions.
Source: IMF World Economic Outlook — Reassessing the Role of Fiscal Policy