Multiplier (economics)

In economics, a multiplier is a factor of proportionality that measures how much an endogenous variable changes in response to a change in some exogenous variable.

That is, suppose a one-unit change in some variable x causes another variable y to change by M units. Then the multiplier is M.

Common uses

Two multipliers are commonly discussed in introductory macroeconomics.

Money multiplier

Main article: Money multiplier

See also: Fractional-reserve banking

In monetary macroeconomics and banking, the money multiplier measures how much the money supply increases in response to a change in the monetary base.

The multiplier may vary across countries, and will also vary depending on what measures of money are considered. For example, consider M2 as a measure of the U.S. money supply, and M0 as a measure of the U.S. monetary base. If a $1 increase in M0 by the Federal Reserve causes M2 to increase by $10, then the money multiplier is 10.

Fiscal multipliers

Main article: Fiscal multiplier

Multipliers can be calculated to analyze the effects of fiscal policy, or other exogenous changes in income and spending, on aggregate output.

For example, if an increase in German government spending by €100, with no change in taxes, causes German GDP to increase by €150, then the spending multiplier is 1.5. Other types of fiscal multipliers can also be calculated, like multipliers that describe the effects of changing taxes (such as lump-sum taxes or proportional taxes).

Keynesian multiplier

Keynesian economists often calculate multipliers that measure the effect on aggregate demand only. (To be precise, the usual Keynesian multiplier formulas measure how much the IS curve shifts left or right in response to an exogenous change in income or spending.) Opponents of Keynesianism have sometimes argued that Keynesian multiplier calculations are misleading; for example, according to the theory of rational expectations, it is impossible to calculate the effect of deficit-financed government spending on demand without specifying how people expect the deficit to be paid off in the future.

General method

The general method for calculating long-run multipliers is called comparative statics. That is, comparative statics calculates how much one or more endogenous variables change in the long run, given a permanent change in one or more exogenous variables. The comparative statics method is an application of the Implicit Function Theorem.

Dynamic multipliers can also be calculated. That is, one can ask how a change in some exogenous variable in year t affects endogenous variables in year t, in year t+1, in year t+2, and so forth. A graph showing the impact on some endogenous variable, over time (that is, the multipliers for times t, t+1, t+2, etcetera), is called an impulse-response function. The general method for calculating impulse response functions is sometimes called comparative dynamics.

History

Illustration of the original visualisation of the tableau économique by Quesnay, 1759.

The tableau économique (Economic Table) of François Quesnay (1759), which lay the foundation of the Physiocrats economic theory, is credited as the "first precise formulation" of interdependent systems in economics and the origin of multiplier theory. In the tableau économique, one sees variables in one period (time t) feeding into variables in the next period (time t+1), and a constant rate of flow yields geometric series, which computes a multiplier.

The modern theory of the multiplier was developed in the 1930s, by Kahn, Keynes, Giblin, and others, following earlier work in the 1890s by the Australian economist Alfred De Lissa, the Danish economist Julius Wulff, and the German-American economist N. A. J. L. Johannsen.