Fiscal Multiplier
What is Fiscal Multiplier?
How much total output changes for each dollar of government spending or tax cuts.
Understanding Fiscal Multiplier
Government spending becomes someone's income, part of which they spend, which becomes someone else's income, and so on. The multiplier measures the total effect on GDP.
In the simplest Keynesian model the multiplier is 1/(1 − MPC). Real-world estimates are much smaller because of taxes, imports, saving and policy responses, and they are larger in deep recessions with idle resources than near full employment.
Formula
Example
With an MPC of 0.8, the simple multiplier is 1/(1 − 0.8) = 5: $100 of new spending could raise output by up to $500 in the basic model.