[1] Some other schools of economic thought reject or downplay the importance of multiplier effects, particularly in terms of the long run.
The multiplier effect has been used as an argument for the efficacy of government spending or taxation relief to stimulate aggregate demand.
The multiplier effect is exploited by governments attempting to use fiscal stimulus policies to increase the general level of economic activity.
The existence of idle capacity and involuntary unemployment of labor in the economy can be represented as an output gap—a difference between actual GDP and potential GDP—and a policy of fiscal stimulus may aim at introducing sufficient additional spending, amplified by the multiplier, to speed the closing of the output gap.
The argument that the choice of taxes or borrowing to finance government spending must be equivalent in that taxpayers observe borrowing and save in anticipation of taxes to repay the borrowing is known as Ricardian Equivalence, and is sometimes cited as a rationale for believing that fiscal stimulus policy will be made futile by the reactions of rational consumers and businesses, reducing their spending or investing in exact proportion to increases in public spending, in a scenario similar to that envisioned in the Treasury View.
Whether an incremental increase to government spending will have a multiplier effect is thought to depend on circumstances in the economy: first, particularly on the extent to which unemployment of resources may be high, so that the additional demand represented by government purchases may be realized by additional production and higher utilization of resources, without bidding up prices; second, by the state of the financial and credit markets, where demand for money and money instruments may welcome additional government debt as low-risk securities, but may regard investment in private production capacity or capital formation as too risky, given a low level of general business activity.
When unemployment of resources in the economy is high, and cash, in effect, is being hoarded in the financial and credit system, the fiscal multiplier may be 1 or greater.
[5] Government borrowing to finance additional public purchases in circumstances in which cash is being hoarded in the financial and credit system will not displace private investment spending.
In such circumstances, policy to increase aggregate demand and total business activity by means of fiscal measures may treat additional purchases and reductions in taxes as interchangeable near equivalents, with the changes in the net difference between spending and taxation identified as the deficit-financed fiscal stimulus.
How potent a fiscal stimulus is in stimulating expansion of economic activity may depend on how accommodating the monetary authority—the central bank—is.
In a case in which there appears to be substantial, persistent unemployment, it can be argued that opportunity costs for public spending are reduced, to the extent that the multiplier exceeds 1.
Whether that would or should justify otherwise wasteful government spending is controversial, on the one hand, and on the other hand, whether the supposed wastefulness of government spending justifies reducing multiplier estimates that reflect only GDP effects to smaller estimates reflecting welfare effects, remains a matter of political controversy.
For example, building a new factory may lead to new employment for locals, which may have knock-on economic effects for the city or region.
In congressional testimony given in July 2008, Mark Zandi, chief economist for Moody's Economy.com, provided estimates of the one-year multiplier effect for several fiscal policy options.
The economists used mafia influence as an instrumental variable to help estimate the effect of central funds given to local councils.
[10] In October 2012 the International Monetary Fund released their Global Prospects and Policies document in which an admission was made that their assumptions about fiscal multipliers had been inaccurate.
This admission has serious implications for economies such as the UK where the OBR used the IMF's assumptions in their economic forecasts about the consequences of the government's austerity policies.
This phenomenon is argued to be less likely to occur in a recession, when the saving rate is traditionally higher and capital is not being fully utilized in the private market.
This has traditionally been regarded as construction or other major projects (which also bring a direct benefit in the form of the finished product).
Indeed, the extent to which a rise in ongoing pension or benefit payments results in the recipient having confidence in their financial future can actually see that individual's MPC exceed 1.
Other individuals with a high, and benevolent, MPC would include almost anyone on a low income — students, parents with young children, and the unemployed.