Definition
Multiplier Effect
The fiscal multiplier effect is the ratio by which an initial change in government spending or taxation changes overall economic output, as money re-circulates through the economy.
When the government spends ₹100 on infrastructure, the contractor pays workers who spend their wages, which becomes others' income, and so on. The total boost to GDP can exceed the original ₹100, giving a multiplier above 1.
The size depends on how much people spend versus save (the marginal propensity to consume) and on leakages like imports and taxes. Capital spending tends to have a higher multiplier than revenue spending, a key argument in India's budget debates over capex.
Related terms
- Fiscal PolicyFiscal policy is the government's use of taxation and spending decisions, set out mainly in the Union Budget, to influence the economy.
- Keynesian EconomicsKeynesian economics argues that aggregate demand drives output and employment, and that governments should use fiscal and monetary policy to stabilise the economy in downturns.
- Velocity of MoneyThe velocity of money is how many times a unit of currency is spent on goods and services in a given period; higher velocity means money circulates faster through the economy.
- Crowding OutCrowding out is when heavy government borrowing soaks up available funds and pushes up interest rates, leaving less and costlier credit for private businesses.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.