Question

4. Explain the GDP multiplier and how it works. How much of the negative GDP gap which existed in 2009 was closed by the almost 800B$ increase in G? What was the actual multiplier? Were the tax dollars well spent for the economic recovery? Why or why not?

Answer 1

GDP multiplier is an economic factor such as government spending of a certain amount of money, or lowering or increasing of taxation by a certain amount of money, that when changed ( increased or decreased ) causes changes in the GDP by multiples of the input economic factor.

When the government invests certain amount of money, say $250 million in a housing project, the increase in GDP equivalent due to this may be more than $250 million if the GDP multiplier is positive, likewise if the multiplier is negative, it will lead to fall in GDP.

The GDP had fallen by 2.5% in real terms in the fiscal year 2009. The stimulus bill of $800 billion closed the negative GDP gap of at least $350-400 billion. The actual multiplier was approximately 0.5.

The fact that the Recovery Act was able to bring back the employment levels as well as the GDP growth rate to the earlier levels within 1-2 years shows that the tax dollars were well spent for the economic recovery. Many economists such Paul Krugman have said that the stimulus package was too small. That could be a point of debate. But the reason American economy could recover so quickly was mainly because of the government spending worth $800 billion.