fiscal multiplier
When the government spends a dollar, the story does not end there. Suppose it pays a builder 1,000 dollars to repair a road. The builder spends some of that on groceries; the grocer spends some on rent; the landlord spends some at a restaurant — and so on, the same dollars circulating and being earned again and again. Because one person's spending is another person's income, the original 1,000 dollars can lift total economic activity by more than 1,000. The fiscal multiplier measures how much total output rises for each dollar of government spending or tax change.
Here is the mechanism in numbers. Imagine people spend 80 percent of any extra income they receive and save the other 20 percent (this fraction is the marginal propensity to consume). The government's 1,000 becomes 800 of new spending by the builder, then 640 by the grocer, then 512, and so on. Summing the shrinking chain gives 1,000 / (1 − 0.8) = 5,000 — a multiplier of 5 in this simplified model. The higher the share people re-spend, the bigger the multiplier. Tax-cut multipliers tend to be smaller than spending multipliers, because some of a tax cut gets saved rather than spent immediately. Real-world leakages (saving, imports, taxes) make actual multipliers much smaller than the textbook figure.
The fiscal multiplier is central to the case for using government spending to fight recessions: if the multiplier is above 1, stimulus pays for part of itself by boosting incomes and tax revenue. But its size is one of the most contested numbers in macroeconomics. Estimates range from below 1 to above 2 depending on circumstances. Crucially, the multiplier is large when there is spare capacity and idle workers (a deep recession), and small or even near zero when the economy is already at full employment — in which case extra government spending mostly crowds out private spending or fuels inflation rather than adding real output. So the honest answer to 'how big is the multiplier?' is: it depends.
If households re-spend 80 cents of every extra dollar, a 1 billion road-building program could in theory raise total output by 5 billion (1 / (1 − 0.8)). In practice, money leaking into savings, taxes, and imports — and a near-full-employment economy — typically shrinks the real multiplier well below that.
One dollar spent can circle the economy many times — but leakages shrink the real effect.
The multiplier is not a fixed constant. It is large with idle resources in a slump but can fall near zero at full employment, where extra spending mostly crowds out or inflates rather than adding output.