Question

During the period of the “Great Moderation”(the mid-1980s through the mid-2000s), discussion of the Keynesian expenditure multiplier had largely gone out of fashion. After all, if business cycles were largely tamed, the effects of a significant demand shock seemed irrelevant. When the Great Recession hit at the end of 2007, the expenditure multiplier became a hot topic again for discussion among macroeconomists.

Why does the size of the expenditure multiplier matter in the real world? why does it matter to businesses, employees, consumers and policy makers?

Based on what you know about the multiplier, do you think the government took the appropriate response to the Great Recession? was the fiscal stimulus response to the recession enough just right , or too much?

Answer 1

An expenditure multiplier explains the ratio of the change in aggregate production to any autonomous change in aggregate expenditure, eg. government expenditure. The only induced expenditure in this case is consumption. When the U.S. investment market collapsed in 2007 the housing market fell as well leading the U.S. economy in a Great Recession. The fall in GDP due to investment was a more than proportional impact, i.e., suppose the investments fell by $100 million, the GDP in this case would fall by more than $100 billion. With a fall in any expenditure category, the impact in the fall of GDP would be more.

In an economy, the expenditure circles within: households buy goods from firms, these firms use the money received to pay their workers, the workers in return buy from other firms to fulfill their consumption needs, and so on. Hence, the change in aggregate expenditure is spent more than once. An initial increase in spending would cycle repeatedly within the economy and result in a larger impact than the initial amount spent. Suppose the government invests in the economy and spends a huge amount of money on goods and services. This would result in an increase in income for the traders and producers dealing with those particular good sand services. These producers would see an increase in their income. This increased income would help them pay their rents, wages, suppliers, etc. Any extra income would go to the shareholders' as extended profit. These shareholders' would in addition use their extra income to buy goods and services from other sellers and producers. In this entire process, the income generated is more than the initial increase in spending.

.In the real, the multiplier value is smaller, as there are more options than just investments and savings. There are taxes that have to be paid, etc. which reduce the multiplier amount. These additional factors are called leakages. If leakages are small, then the multiplier effect would be larger.

The Government stimulus in the economy during the 2007 recession was enough to bring the economy back into functioning.