Question

Does the “spending multiplier effect” make fiscal policy more effective, or less? Explain briefly.

Answer 1

Answer: The spending multiplier increases the effect of fiscal policy on the output or real GDP. It increases effectiveness of the fiscal policy. The spending multiplier in closed and open economy are given in the attached picture. The fiscal policy involves tax rates and government expenditure. Changes in either of the variable would affect the output level by multiplier times. The multiplier multiplies the change in these variables to great extent on the output. The equations are mentioned in the images, how change in the government expenditure or in the tax rate would impact the output level.

Suppose, the value of multiplier is 4, the government expenditure changes by $100, then the output rises by 4x100 = $400. Therefore, the output has increased more than the rise in government expenditure.