In Economics, what is a Multiplier?

A multiplier is something that affects a system by making a change from the outside, causing interconnected elements of the system to move in response. Some examples of multipliers include fiscal policy decisions made by governments and the ability of banks to lend. In both cases, in addition to having immediate effects like raising taxes or making more credit available, the multiplier is associated with a chain reaction and a series of changes throughout the system. These changes can be predicted by economists to gauge the impact before the decision is made.

Multipliers are used to measure proportional changes in a system. Economists look both at positive changes that can be accomplished with a single multiplier, such as a decrease in the unemployment rate caused by more availability of credit and subsequent employment opportunities, and negative changes, like a decrease in consumer spending caused by tax increases. When developing economic and fiscal policy, the multiplier effect must be considered.

The interconnected nature of economist systems is an important thing to weigh when thinking about the impact of a change on the system. In the example of taxation, lowering taxes does more than increasing personal spending because people retain more of their paychecks. It also lowers government revenues, but can also stimulate economic growth as consumers demand more products and companies increase production and expand to meet the demand. Economists making decisions think about how the multiplier will play out across the system to decide if a change will net positive or negative effects.

Governments generally want to promote stable, regular economic growth with the goal of remaining fiscally stable and keeping the population satisfied with economic conditions. Economic decline can be a cause for concern, as can rapid acceleration indicative of a bubble phenomenon. Numerous tools have been developed to quantify and explore the behaviors of national economies, as well as those on a smaller scale, and the multiplier — an external factor with a proportional impact on the economy — is an important concept.

People can see examples of the multiplier at work in a wide variety of settings, as businesses and governments alike make policy changes designed to develop economies, as well as expand businesses. Sometimes, economic predictions backfire and a policy change may not have the desired effect; for instance, instead of spending money when taxes are reduced, taxpayers might set aside their increased income in savings to address concerns about future cashflow problems and other issues.