Fiscal Multiplier

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Definition of 'Fiscal Multiplier'

The fiscal multiplier is the ratio of the change in national income to the change in government spending. It is a measure of the effect of government spending on economic output.

The fiscal multiplier is greater than one because when the government spends money, it creates income for the people who receive the money. This income is then spent, which creates more income for other people, and so on. This process of "multiplier" effects can lead to a significant increase in national income.

The size of the fiscal multiplier depends on a number of factors, including the marginal propensity to consume, the interest rate, and the exchange rate. The marginal propensity to consume is the proportion of an increase in income that is spent. The higher the marginal propensity to consume, the greater the fiscal multiplier. The interest rate is the cost of borrowing money. A higher interest rate reduces the amount of money that people and businesses are willing to borrow, which reduces the amount of spending and the size of the fiscal multiplier. The exchange rate is the price of one currency in terms of another. A weaker exchange rate makes imports more expensive and exports more profitable, which can lead to an increase in spending and the size of the fiscal multiplier.

The fiscal multiplier is an important concept for understanding the effects of government spending on the economy. It can be used to assess the impact of proposed government spending programs and to make decisions about how to allocate government resources.

In addition to the factors mentioned above, the size of the fiscal multiplier can also be affected by the state of the economy. In a recession, the fiscal multiplier is likely to be larger than in a period of economic growth. This is because people are more likely to spend money when they are worried about their jobs and the future. The fiscal multiplier can also be affected by the type of government spending. Spending on infrastructure and other projects that create jobs is likely to have a larger multiplier effect than spending on transfer payments, such as social security and welfare.

The fiscal multiplier is a complex concept, and there is some debate about its exact size. However, it is clear that government spending can have a significant impact on the economy. By understanding the fiscal multiplier, policymakers can make more informed decisions about how to use government spending to promote economic growth.

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