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What is an Expenditure Multiplier?

John Lister
John Lister

An expenditure multiplier is the ratio between a specific change in spending and the resulting change on a measure of national income, such as gross domestic product. It plays a key part in Keynesian economics. This is based on the theory or argument that the expenditure multiplier can equal more than one, meaning the spending produces a greater return in the context of the entire economy.

In its simplest form, an expenditure 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 figures will be positive, but this is not necessarily the case. Because of the difficulty in specifically linking one economic activity to another, it is arguable the ratio, and the underlying link between the two figures, it somewhat hypothetical.

John Maynard Keynes.
John Maynard Keynes.

In economic theory, if the expenditure multiplier is more than one, the underlying cause and effect are known as a multiplier effect. The most common attempt to explain the practical events that cause 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 causing a virtuous circle.

The multiplier effect is one of the main planks of Keynesian economics, a wide field of theories named after economist John Maynard Keynes. Keynesian economics argues that government expenditure can help to stimulate an economy, and that the multiplier effect means the benefits to the economy outweigh the immediate cost. Government expenditure in this sense does not solely mean spending money, but can also cover tax cuts, which also mean more people have more money to spend. The main alternative set of theories to Keynesian economics is monetary policy, which argues in favor of governments manipulating the cost and availability of credit in order to change the economic climate.

While few economists completely reject the existence of a multiplier effect, there is debate about how strong the effect is in every circumstances. In some cases, the effect may be limited because the people receiving the initial benefit of the extra money may not spend all of it, instead opting to save it. In other cases, there is an argument that government spending takes business away from the private sector to the point that the expenditure multiplier is less than one, meaning the costs outweigh the overall benefit. In extreme circumstances, it is possible that a government that runs up a deficit to fund spending designed to stimulate an expenditure multiplier may force interest rates up, thus limiting borrowing for investment in the private sector.

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    • John Maynard Keynes.
      John Maynard Keynes.