Posted on by John Sloman

Multiplication was never going to be easy

In an attempt to stave off recession, countries around the world have made extensive used of fiscal stimuli. Combinations of tax cuts and increases in government expenditure have been used to boost aggregate demand and thereby to halt falling national income. “The G20 group of economies … have introduced stimulus packages worth an average of 2% of GDP this year and 1.6% of GDP in 2010.”

But how much will national income respond to a particular fiscal stimulus? It depends on the size of the fiscal multiplier for each type of government expenditure increase or tax cut. The bigger the multiplier for each expansionary measure, the more will national income rise. Clearly, to estimate the effects of their fiscal measures, governments would very much like to know the size of these multipliers. But that’s not so easy, as the following article from The Economist explains.

Much ado about multipliers The Economist (24/9/09)

Questions

  1. What are the formulae for (a) the government expenditure multiplier; (b) the tax multiplier?
  2. Why is the value of the multiplier likely to vary with the type of government expenditure increase or tax cut that is used? Which types of government expenditure increases and tax cuts are likely to have (a) the largest effects; (b) the fastest acting effects?
  3. Why is the size of any particular fiscal multiplier difficult to predict? How do expectations impact on the size of the multiplier?
  4. Under what circumstances are fiscal measures likely to be ‘crowded out’? How can monetary policy be used to prevent, or at least minimise, crowding out?