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The expenditure multiplier is a ratio of a change in expenditure to the resulting change in national income. It plays a key role in Keynesian economics, which argues that government spending can stimulate an economy and create a virtuous circle. However, there is debate about the strength of the multiplier effect and its limitations.
An expenditure multiplier is the ratio of a specific change in expenditure to the resulting change in a measure of national income, such as gross domestic product. It plays a key role in Keynesian economics. This is based on the theory or argument that the spending multiplier can equal more than one, meaning that spending produces a greater return in the context of the whole economy.
In its simplest form, an expense multiplier is a purely objective mathematical measure. It is calculated by dividing a change in national income by the change in spending that specifically caused that change in income. Most commonly, both digits will be positive, but that’s not necessarily the case. Because of the difficulty in specifically linking one economic activity to another, the relationship is questionable, and the underlying link between the two figures is rather hypothetical.
In economic theory, if the spending multiplier is more than one, the underlying cause and effect is known as the multiplier effect. The most common attempt to explain the practical events causing the effect is to argue that a spending program leads to increased employment. This means more people have more money available to spend on other products, increasing demand. This in turn creates more jobs in manufacturing those products, further increasing the money people have to spend and thus creating a virtuous circle.
The multiplier effect is one of the main axes of Keynesian economics, a large field of theories named after the economist John Maynard Keynes. Keynesian economics argues that government spending can help stimulate an economy and that the multiplier effect means that the benefits to the economy outweigh the immediate costs. Government spending in this sense is not just about spending money, it can also cover tax cuts, which also means that more people have more money to spend. The main alternative set of theories to Keynesian economics is monetary policy, which argues for governments manipulating the cost and availability of credit to change the economic climate.
While few economists outright reject the existence of a multiplier effect, there is debate about how strong the effect is under any circumstances. In some cases, the effect may be limited because people who receive the initial benefit of the extra money may not spend it all, opting instead to save it. In other cases, government spending is argued to drive assets away from the private sector to the point that the spending multiplier is less than one, meaning that the costs outweigh the overall benefit. In extreme circumstances, it is possible that a government running a deficit to finance spending designed to stimulate a spending multiplier could drive up interest rates, thereby limiting leverage for private sector investment.
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