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In economics, the '''multiplier effect''' refers to the fact that an increase of an economic aggregate may lead to an increase of this aggregate or another greater than the initial raise.
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The '''multiplier effect''' is the effect of an injection of income into an economy upon the total income of that economy.  It is  a definitional consequence<ref> As is demonstrated in the article on the [[spending multiplier]]</ref> of the [[Macroeconomics#The circular flow of income|circular flow of income]] model of the economy. The effect is to raise the total  income of the economy by a multiple of the initial injection. The magnitude of the effect is limited by  "leakages" from the injected income into, for example, taxation or spending on imports. If the recipients of the increases in income would otherwise be unemployed, the effect takes the form of an increase in  the level of activity in the economy. If they would otherwise be fully employed, it takes the form of an increase in the general level of prices.


The multiplier effect is also known by bankers. An initial mortgage creates a deposit on a client account. This deposit can be partially lent to another client and so on.
The basic [[spending multiplier]] model embodies  the implicit assumption that income leakages are a fixed proportion of the initial injection, and that the multiplier is consequently invariable. They assume, for example, that a community's [[marginal propensity to save]] is a behavioural constant. More sophisticated models take account of the effect upon behaviour of the perceived permanence or otherwise of the income injection.  Robert Barro has argued that the multiplier effect of an increase in public spending is zero because taxpayers  save an equivalent amount in anticipation of a subsequent  tax increase<ref>Robert J. Barro: ''Reflections on Ricardian Equivalence'',  National Bureau of Economic Research  Working Paper No. w5502, March 1996</ref>. The multiplier effect may also be influenced by changes that are associated with the initial injection. It has been  argued that interest rate increases caused by government spending cause an offsetting "crowding out" of private sector investment
<ref>[https://research.stlouisfed.org/publications/review/70/10/Expenditures_Oct1970.pdf Roger Spencer and William Yohe: ''The "Crowding Out" of Private Expenditures by Fiscal Policy Actions'', Federal Reserve Bank of St Louis, October 1970]</ref>. The multiplier effect  may also be influenced by  the state of the economy at the time of the injection. Following the bursting of an [[asset price bubble|house price bubble]], for example, households may use additional income to repay debt instead of spending it.  


== Spending multiplier ==
In the context of [[fiscal policy]] the initial injection of income may take the form, either of an increase in [[public expenditure]], without a balancing increase in [[taxation]], or of a reduction in the revenue from taxation without a balancing reduction in public expenditure. In either case it is met by borrowing and involves an increase in the government's [[budget deficit]]. Correspondingly, the multiplier effect operates to reduce total income when [[fiscal consolidation]] action is taken to reduce the budget deficit.


This multiplier effect is an important idea according to Keynesian economists. It explains how a budget deficit can have a strong influence on the national output, depending on the propensity to consume. The governmental spending creates a new income for private agents who will spend a part of it and so on.
Fiscal policy is normally concerned with the effect of upon ''output'' of changes in the budget balance, and that depends upon how far the economy is from [[full employment]]. (As already noted, if all recipients of income were fully employed, the multiplier effect would be confined to an increase in the general level of prices, with no effect upon output.) When the term "multiplier"  is used without qualification to denote a numerical value, it is the effect upon the "real" (inflation-corrected) value of output that is normally referred to. Also, the numerical values quoted normally refers to the first-year effect of the policy change. Most estimates of the magnitude of the multiplier, so defined, have been in the range of 0.4 to 1.2, but multipliers have been found to be larger than average during periods of economic crisis<ref>[http://ec.europa.eu/economy_finance/publications/economic_paper/2012/pdf/ecp460_en.pdf Jocelyn Boussard, Francisco de Castro and Matteo Salto: ''Fiscal Multipliers and Public Debt Dynamics in Consolidations'', European Commission, July 2012]</ref>.
The policy implications of such multiplier estimates are examined in the article on the [[fiscal multiplier]].


Imagine an closed economy in which private agents consume in average 80% of their income. If the government increases its purchases by 100, then the national output will increase by 500.
==References==
<center>
{{reflist}}[[Category:Suggestion Bot Tag]]
{| class="wikitable"
|-
! Agent
! Consumption
! Saving
|-
| Government
| 100
| 0
|-
| Client of the previous agent
| 80
| 20
|-
| Client of the previous agent
| 64
| 16
|-
| Client of the previous agent
| 51
| 13
|-
| Client of the previous agent
| 41
| 10
|-
| Client of the previous agent
| 33
| 8
|-
| Client of the previous agent
| 26
| 6
|-
| and so on ...
| ...
| ...
|-
! Total
! 500
! 125
|}
</center>
 
In mathematics, this result is known as the sum of a convergent [[geometric serie]].
 
An other demonstration relies on the following accountant relation in a closed economy :
<center>
Income = Consumption + Investment<br>
Income = Private Consumption + Governmental Consumption + Saving - Taxes<br>
Y = C + G + I - T<br>
Since C = cY with c the propensity to consume, then<br>
Y = cY + G + I - T<br>
(1-c)Y = G + I - T<br>
Y = (G + S - T)/(1-c)<br>
Thus, an increase of G by 1 implies an increase of Y by 1/(1-c).
</center>

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The multiplier effect is the effect of an injection of income into an economy upon the total income of that economy. It is a definitional consequence[1] of the circular flow of income model of the economy. The effect is to raise the total income of the economy by a multiple of the initial injection. The magnitude of the effect is limited by "leakages" from the injected income into, for example, taxation or spending on imports. If the recipients of the increases in income would otherwise be unemployed, the effect takes the form of an increase in the level of activity in the economy. If they would otherwise be fully employed, it takes the form of an increase in the general level of prices.

The basic spending multiplier model embodies the implicit assumption that income leakages are a fixed proportion of the initial injection, and that the multiplier is consequently invariable. They assume, for example, that a community's marginal propensity to save is a behavioural constant. More sophisticated models take account of the effect upon behaviour of the perceived permanence or otherwise of the income injection. Robert Barro has argued that the multiplier effect of an increase in public spending is zero because taxpayers save an equivalent amount in anticipation of a subsequent tax increase[2]. The multiplier effect may also be influenced by changes that are associated with the initial injection. It has been argued that interest rate increases caused by government spending cause an offsetting "crowding out" of private sector investment [3]. The multiplier effect may also be influenced by the state of the economy at the time of the injection. Following the bursting of an house price bubble, for example, households may use additional income to repay debt instead of spending it.

In the context of fiscal policy the initial injection of income may take the form, either of an increase in public expenditure, without a balancing increase in taxation, or of a reduction in the revenue from taxation without a balancing reduction in public expenditure. In either case it is met by borrowing and involves an increase in the government's budget deficit. Correspondingly, the multiplier effect operates to reduce total income when fiscal consolidation action is taken to reduce the budget deficit.

Fiscal policy is normally concerned with the effect of upon output of changes in the budget balance, and that depends upon how far the economy is from full employment. (As already noted, if all recipients of income were fully employed, the multiplier effect would be confined to an increase in the general level of prices, with no effect upon output.) When the term "multiplier" is used without qualification to denote a numerical value, it is the effect upon the "real" (inflation-corrected) value of output that is normally referred to. Also, the numerical values quoted normally refers to the first-year effect of the policy change. Most estimates of the magnitude of the multiplier, so defined, have been in the range of 0.4 to 1.2, but multipliers have been found to be larger than average during periods of economic crisis[4]. The policy implications of such multiplier estimates are examined in the article on the fiscal multiplier.

References