Posts tagged “fiscal multiplier”

A model economy with government money and private wealth target
A self-limiting private sector and a stabilizing economy

This post will describe another complete - but simple - model economy. It follows directly from the previous model and introduces one fairly simple innovation. In the last model the private sector spent a certain proportion of it's disposable income, saving the rest. In this model the private sector spend out of both income and saved wealth. The introduction of spending out of wealth in the only difference. This model is the starting point for the stock-flow consistent models described in Monetary Economics by Wynne Godley & Marc Lavoie (model "SIM").

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A simple economy with government money
A simple but rigorous accounting of economic flows and sectoral balances through time

This post describes a complete, if very simple, economic model. We'll use the insights and mathematical formulations developed previously (e.g. here, here, and here) but these will be anchored within a wider accounting and modelling framework which helps us to organise our model components and ensure that the model is coherent.

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Modelling the fiscal multiplier
Some additional considerations for modelling building

This is the third post in a series of posts looking at the fiscal multiplier. Previously, we have examined how the circular flow of money interacts with government spending and taxation (as well as private saving) by considering a mathematical structure called a geometric series. This interpretation of the fiscal multiplier is based around the concept of "spending rounds" which represent successive events in which income received previously is spent onwards, creating new income which is spent in the next round, and so on. Each spending round involves a successively smaller amount of circulating money because a fraction of all income is collected in tax (or saved). Eventually, all of the money has been withdrawn from circulation via taxation (and saving) and the spending stops. In the interim period, the circulation of the ever-reducing money stock produces a total, cumulative amount of income.

This approach is an intuitive way of thinking about sequences of spending. It enables us to conceive of how the money initially introduced by government spending is passed around the economy and what the implications of taxation and saving are. But whilst it arguably does a good job of describing how individual acts of spending follow the receipt of income, it should be recognised that in real economies collective spending does not precede collective income in discrete, ordered stages. Spending and the receipt of incomes arise via an incredibly complex network of millions of overlapping transactions occuring continuously.

The concept of the spending round also leads to questions such as how long it takes for a single spending round to occur, or the number of rounds that should be considered. It seems reasonable, for example, that the number of spending rounds included in any analysis would depend on the time period under consideration. But it is not really clear how spending rounds relate to absolute time. However, it turns out that these concerns can be adequately side-stepped by using a coherent accounting framework. This post attempts to tighten up our understanding of the fiscal multiplier and presents an alternative mathematical derivation which is more conducive to inclusion in more complex models.

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Government money and saving
How private sector saving affects the fiscal multiplier and the government's budget

In the last post we looked at they way in which government spending and taxation interacts with the circular flow of money. In particular, we found that, in an economy with no saving, money introduced by the government is repeatedly spent creating additional income beyond that created by the initial government spending. Since the government collects an income tax on each transaction, the money introduced by the government spending is gradually withdrawn as it is re-spent. This "leakage" of money out of circulation places a limit on the total amount of spending and income that can ultimately arise. The eventual total level of aggregate income was shown to be a multiple, \(\frac {1}{\theta}\), of the initial government spend (where \(\theta\) is the tax rate). Here we'll consider what changes in this story when the population decide to save some of their income.

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The circular flow of government money
Government spending, taxation and the fiscal multiplier

The term fiscal policy describes the spending and taxation decisions taken by government and is used to differentiate these policies from other economic policies of government such as the setting of interest rates (monetary policy). The impact of the circular flow of money on incomes is complicated by government spending and taxation and the effect is encapsulated in a concept called the fiscal multiplier which is the focus of this post.

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