The fiscal multiplier measures the impact of government spending on the economy from "summary" of Public Finance by Harvey S. Rosen
The fiscal multiplier captures the idea that an initial change in government spending can lead to a larger change in aggregate output. In other words, when the government increases its spending, this injection of funds can set off a chain reaction of increased economic activity. This multiplier effect occurs because the recipients of government spending will in turn spend part of that money, leading to further rounds of spending in the economy. The size of the fiscal multiplier depends on a variety of factors, including the marginal propensity to consume (MPC) of households. The MPC refers to the fraction of additional income that households spend on consumption. If households have a high MPC, then an increase in government spending will lead to a larger increase in aggregate demand. This, in turn, will lead to a higher fiscal multiplier. Additionally, the fiscal multiplier can also be influenced by the state of the economy. During times of economic recession or slack, the fiscal multiplier is likely to be higher as there is excess capacity in the economy. In such situations, an increase in government spending can help to stimulate economic activity and bring about a faster recovery. On the other hand, during times of economic boom or full employment, the fiscal multiplier may be lower as there is less room for additional output. In this case, an increase in government spending may lead to inflationary pressures rather than a significant increase in output.- The fiscal multiplier is an important concept in understanding the impact of government spending on the economy. By considering factors such as the MPC and the state of the economy, policymakers can better assess the effectiveness of fiscal policy in stimulating economic growth and managing business cycles.
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