January 21, 2022 5:23 pm

“Multiplier” effect: what happens when more money is poured into the economy?

1. Multiplier. In the last week there was an interesting crossover between a current and a former official regarding the impact of a policy on a certain sector and on the economy in general. Both mentioned the concept of the “multiplier” which, in reference to fiscal matters, refers to the impact that an increase in public spending can have on the growth of the economy. But there are also others, such as the monetary multiplier.

2. Monetary. Although the only authorized issuer of pesos is the Central Bank, did you know that there is capacity for private banks to also create them? The multiplier appears here. Let’s imagine that a bank user, Federico, deposits $ 1000. The bank must leave 10% ($ 100) for bank reserve requirements, by regulation of the Central Bank. And you can go out and lend $ 900 to another user, Matías. If the recipient of that money deposits it again, the bank keeps 10% of the $ 900 deposited ($ 90) and lends $ 810 to another. Thus, successively, in a decreasing infinite series. That is, from the initial $ 1000, there is now $ 2710 in circulation, although for some they mean liabilities and for other assets. This, explained in a very simple way, is the multiplied effect that the money supply has on the creation of “secondary” money through private companies.

3. Fiscal. The size of the multiplier depends on the marginal propensity to consume that individuals have and the income tax rate. The logic behind this seems intuitive, if the State makes a monetary transfer to individuals and they tend to spend it 100%, this will have a greater effect on the economy, since companies see greater demand for their products and hire more personnel. . If the trend of those who receive the benefit is to lower consumption, the multiplier effect will be less. In the mother model of all this, the effect is always positive. So why not always spend more, transferring more money from the state to all sectors of society? The problem is that the short term differs from the long term and that the contexts in which the measures are applied can change the outcome of any policy.

4. Contexts. We can think that the spending multiplier from purchases of goods and services made by the State will not work in the same way in a context of an economy in equilibrium, as in one where an external shock has been suffered (such as that caused by the pandemic) . But even the multiplier can be negative if the government has a high deficit, with a corresponding level of debt and does not have access to the global market. If the government gets $ 100 in and you spend $ 120, that $ 20 has to be financed. Something will come from higher collection, because people spend more than what the State granted them, and that generates more VAT and Profits. But the rest will be sought via new taxes, which will generate less activity in other sectors, or via monetary issuance, which will cause higher inflation.

5. Temporary effect. Increases in public spending will have a positive initial effect for the sector to which they are directed. The point is how long this program lasts and what counter effect it may have on another social segment. Permanent programs based on the expansion of public spending will have an inevitable result of a debt or inflation crisis, which will collide with the objectives sought.


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