11.3: How big is the Multiplier?

When President Obama took office on January 1, 2009, the U.S. economy had been in recession for over a year (the recession started in December 2007). The first order of business for the new Administration was to formulate a stimulus package to help move the economy toward full employment (a typical Keynesian approach). The American Recovery and Reinvestment Plan involved spending about $775 billion. 

Here is how President Obama’s Chair of the Council of Economic Advisors summarized the effect the stimulus package will have on the economy: 

For the output effects of the recovery package, we started by averaging the multipliers for increases in government spending and tax cuts from a leading private forecasting firm and the Federal Reserve’s FRB/US model. 

We confess to considerable uncertainty about our choice of multipliers for this element of the package. 

Source: The Job Impact of the American Recovery and Reinvestment 

Plan, January 10, 2009 

The multiplier that was used for government spending was 1.57. In other words, the Administration thinks that an aid package of $775 billion will shift the U.S. AD curve to the right by about $1.2 trillion ($775 b x 1.57). 

The uncertainty expressed in the report about the size of the multiplier was realistic. The truth is no one really knows the size of the fiscal multiplier. However, most economists agree that a fiscal stimulus has some sort of multiplier effect on demand. But this agreement does not change the fact that fiscal policy advocates do not know exactly how far to the right the AD curve will shift after enacting a new spending plan or a tax cut. 

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