Keynesian Multiplier: A Complete Guide
The Keynesian multiplier shows how a small change in spending can create a larger shift in national income, making it essential for economists and policy makers analyzing fiscal stimulus and aggregate demand.
What Is the Keynesian Multiplier?
Introduced by Richard Kahn and expanded by John Maynard Keynes, the multiplier expresses how a shift in autonomous spending alters total output. If government outlays rise $1 billion and GDP grows $1.5 billion, the multiplier is 1.5. This outcome emerges through successive rounds of income and re-spending.
How the Multiplier Works
When new spending enters the economy—whether from public works, tax cuts, or exports—it becomes income for households and firms. Recipients spend a portion and save the rest, determined by the marginal propensity to consume (MPC). Each purchase becomes someone else’s income, creating a demand chain that diminishes over time yet exceeds the original outlay.
Formula and Example
The formula is k = 1 / (1 – MPC). If consumers spend 0.8 of each extra dollar, the multiplier is 5. A $200 million injection would therefore expand GDP by $1 billion. A lower MPC of 0.6 yields 2.5, showing how saving behavior tempers stimulus.
Factors That Influence the Multiplier
Several real-world frictions shrink the theoretical multiplier. High import penetration leaks demand abroad, while progressive taxation siphons off part of each income round. Credit constraints, pessimistic expectations, and capacity limits further curb re-spending. Conversely, automatic stabilizers, targeted transfers, and well-timed infrastructure projects can raise the effective MPC and amplify employment and growth.
Why the Keynesian Multiplier Matters Today
During recessions, central banks may hit the zero lower bound, limiting monetary stimulus. At that point, fiscal measures informed by multiplier analysis become crucial. Policymakers compare programs not only for politics but for expected multipliers; initiatives with high-MPC recipients, such as unemployment benefits or school repairs, usually deliver quicker, larger boosts to GDP and community welfare. Robust multipliers can shorten downturns and help economies return to potential output swiftly and maintain stable prices.