Conversely, during periods of overheating, central banks might consider the multiplier effect when deciding to withdraw liquidity to prevent inflation from spiraling out of control. This means an initial injection of $100 could theoretically generate $500 in total economic output.
Open Economy Multiplier International: How Global Spending Flows Amplify Economic Impact
Essentially, it quantifies the relationship between an autonomous change in aggregate spending and the resulting change in the overall economic activity. When an entity—be it a government, business, or foreign entity—injects new money into an economy, recipients of that spending do not merely save it.
Additionally, high inflation can erode the real value of the initial spending. During a recession, governments often utilize fiscal stimulus—such as increased public works spending—to activate the multiplier.
Open Economy Multiplier: How Global Factors Amplify Economic Impact
The standard formula is 1 divided by (1 minus the MPC), or alternatively, 1 divided by the marginal propensity to save (MPS). Liquidity traps, where interest rates are already low and savings rates are high, can also dampen the effect significantly.
More About What is the multiplier in macroeconomics
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