Money multiplier

Main article: Money multiplier See also: Fractional reserve banking In monetary macroeconomics and banking, the money multiplier measures how much the money supply increases in response to a change in the monetary base. The multiplier may vary across countries, and will also vary depending on what measures of money are considered. For example, consider M2 as a measure of the U.S. money supply, and M0 as a measure of the U.S. monetary base. If a $1 increase in M0 by the Federal Reserve causes M2 to increase by $10, then the money multiplier is 10. [edit]Fiscal

multipliers

Main article: Fiscal multiplier Multipliers can be calculated to analyze the effects of fiscal policy, or other exogenous changes in spending, on aggregate output. For example, if an increase in German government spending by 100, with no change in taxes, causes German GDP to increase by 150, then the spending multiplier is 1.5. Other types of fiscal multipliers can also be calculated, like multipliers that describe the effects of changing taxes (such as lump-sum taxes or proportional taxes). [edit]Keynesian

multiplier

Keynesian economists often calculate multipliers that measure the effect on aggregate demand only. (To be precise, the usual Keynesian multiplier formulas measure how much the IS curve shifts left or right in response to an exogenous change in spending.) Opponents of Keynesianism have sometimes argued that Keynesian multiplier calculations are misleading; for example, according to the theory of Ricardian equivalence, it is impossible to calculate the effect of deficit-financed government spending on demand without specifying how people expect the deficit to be paid off in the future. American Economist Paul Samuelson credited Alvin Hansen for the inspiration behind his seminal 1939 contribution. The original Samuelson multiplier-accelerator model (or, as he belatedly baptised it, the "Hansen-Samuelson" model) relies on a multiplier mechanism which is based on a simple Keynesian consumption function with a Robertsonian lag:

Ct = c0 + cYt 1
so present consumption is a function of past income (with c as the marginal propensity to consume). Investment, in turn, is assumed to be composed of three parts:

It = I0 + I(r) + b(Ct Ct 1)
The first part is autonomous investment, the second is investment induced by interest rates and the final part is investment induced by changes in consumption demand (the "acceleration" principle). It is assumed that 0 < b . As we are concentrating on the income-expenditure side, let us assume I(r) = 0 (or alternatively, constant interest), so that:

It = I0 + b(Ct Ct 1)
Now, assuming away government and foreign sector, aggregate demand at time t is:

Ytd = Ct + It = c0 + I0 + cYt 1 + b(Ct Ct 1)

assuming goods market equilibrium (so Yt = Ytd), then in equilibrium:

Yt = c0 + I0 + cYt 1 + b(Ct Ct 1)
But we know the values of Ct and Ct 1 are merely Ct = c0 + cYt 1 and Ct 1 = c0 + cYt 2 respectively, then substituting these in:

Yt = c0 + I0 + cYt 1 + b(c0 + cYt 1 c0 cYt 2)

or, rearranging and rewriting as a second order linear difference equation:

Yt (1 + b)cYt 1 + bcYt 2 = (c0 + I0)

The solution to this system then becomes elementary. The equilibrium level of Y (call it Yp, the particular solution) is easily solved by letting Yt = Yt 1 = Yt 2 = Yp, or:

(1 c bc + bc)Yp = (c0 + I0)

so:

Yp = (c0 + I0) / (1 c)
The complementary function, Yc is also easy to determine. Namely, we know that it will have the form Yc = A1r1t + A2r2t where A1 and A2 are arbitrary constants to be defined and where r1 and r2 are the two eigenvalues (characteristic roots) of the following characteristic equation:

r2 (1 + b)cr + bc = 0
Thus, the entire solution is written as Y = Yc + Yp