MULTIPLIERS IN ACTION

A realistic understanding of the size of multipliers is a crucial part of diagnosis and prescription in economic policy. Just as a physician prescribing a painkiller must know the effect of different dosages, so an economist must know the quantitative magnitude of expenditure and tax multipliers. When the economy is growing too rapidly and a dose of fiscal austerity is prescribed, the economic doctor needs to know the actual size of multipliers before deciding how large a dose of tax increases or expenditure reductions to order. all major sectors of the economy (including both monetary and financial sectors, along with investment demand schedules and consumption functions), and they incorporate a full set of links with the rest of the’ world. In the estimates, the level of real government purchases of goods and services is permanently increased by $1 billion. The models then calculate the impact on real GDP. The change in real GDP resulting from the increase in government purchases provides an estimate of the size of the government expenditure multiplier.

Figure 24-10 presents the results of this survey. The heavy blue line shows the average government expenditure multiplier estimated by eight models, while the light gray lines show the range of estimates of the individual models. The average multiplier for ·the first and second years is around 1.4, but after the ‘second year the multiplier tends to decline slightly as monetary forces and international impacts come into play. (The monetary forces represent the impact of higher GDP on interest rates, which leads to a
crowding out of investment, as we will explain in later chapters.)

One interesting feature of these estimates is that the different models represented by the light gray lines in Figure 24-10) show considerable disagreement about the size of multipliers. Why do the estimates differ? To begin with, there is inherent uncertainty about the nature “of economic relationships, Uncertainty about the structure of nature or society’ is of course what makes science so exciting; if every· thing were perfectly understood, scientists would be out of business. But understanding economic s}’Stems poses even’ greater challenges because economists cannot conduct controlled experiments in a laboratory. Even ·more vexing ,is the fact that the economy itself evolves over time, so “correct” model for 1960 is different from the “correct” model for 2000.

In addition, economists ,have fundamental disagreements about, the underlying nature of the macro economy. Some economists believe that a Keynesian approach best explains macroeconomic behavior, while others are co minced that a classical or real-business-cycle approach yields better insights. With all these uncertainties and differences in points of view, we can hardly be surprised that economists will provide different estimates of multipliers.

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