Multiplier effect

The multiplier effect is the effect of an injection or withdrawal of income upon the level of activity in an economy. Estimates of its magnitude are consequently a major factor in the formulation of fiscal policy. Its existence, and the factors that determine it, can be established by logical deduction, but estimates of its magnitude depend upon induction from the evidence of past experience. An unavoidable limitation upon the usefulness of past evidence arises from the possibility of a significant change in the factors that influence economic behaviour. Reaction to a fiscal stimulus following the collapse of a housing bubble may differ from what it would have been in the course of a house price boom, because households respond by deleveraging instead of increasing their spending. That is only one example of the non-technical difficulties that add to the technical difficulties of estimating the magnitude of the current multiplier effect