The Fiscal Multiplier
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Last updated 28 Jun 2020
The concept of the fiscal multiplier an important part of the debate over how to avoid a covid-19 economic depression and mass unemployment.
Despite the extraordinary increase in UK government borrowing since the start of the Great Shutdown of the economy in March 2020, most economists believe that a further fiscal stimulus will be needed to prevent the UK experiencing a depression and mass unemployment.
What is the fiscal multiplier?
The fiscal multiplier estimates the final change in real national income (GDP) that results from an initial (exogenous) change in government spending and/or revenue plans.
What is a simple numerical example of the fiscal multiplier?
For example, if a £5 billion increase in government spending on flood defence leads to a £12 billion final increase in real GDP, then the fiscal multiplier = £12 billion / £5 billion = +2.4
What is the possible significance of a high value for the fiscal multiplier?
If the fiscal multiplier is a high positive number, then a well-timed fiscal stimulus might be highly effective in helping to lift aggregate demand, production, incomes and jobs as an economy tries to recover from a deep recession / downturn.
Evaluation: The size of the fiscal multiplier depends on
- How the fiscal stimulus is financed e.g. via increased borrowing
- Extent to which a stimulus leads to higher interest rates / inflation
- Degree to which an economy is open to imports (M is a leakage)
- Impact on consumer & business expectations and confidence
- Marginal propensity to consume and save of households affected