The principle of the fiscal multiplier is a macroeconomic mechanism highlighted in the early 1930s by Richard Kahn, who initially links changes in employment with those of public spending.
This principle was extended by John Maynard Keynes in The General Theory of Employment, Interest, and Money in 1936. He updates a relationship between the change in economic activity and a change in expenditure. public. Since then, we know that the fiscal multiplier is equal to the ratio between the change in GDP and that of public expenditures, which is generally greater than unity; that is why we use the term “multiplier”. This amounts to attributing the change in activity to changes in public expenditure. The higher the ratio, the more effective the state intervention on activity, via fiscal policy.
How does this mechanism work? Let’s reason with a simple example. When the State makes an additional order to a company, the production of the latter will be added to the national production for an equivalent amount. In response to this market, this company will use labor to pay wages, consume intermediate products and generate profits. Both employees and business owners receive a purchasing power that they will use by buying goods and services that they would not have consumed without the prior public order. Subcontractors or suppliers are in the same situation. Part of the consumption generated will be from other resident companies. These same companies will, in turn, contribute to the increase in domestic production and provide revenue to the economy that will support a further increase in demand for goods and services. For one euro of public expenditure, economic activity will have increased by more than one euro. The reasoning boils down to the image of a virtuous circle, the initial fiscal stimulus generates an increase in national production higher than this impulse. In a situation of demand crisis, especially when monetary policy is ineffective, as is currently the case in the eurozone, it is essential for the state to intervene using the leverage of public spending.
This virtuous circle is however not infinite, it contains three limits.
First, supplementary income is never entirely spent on domestically produced goods. One part is used for the purchase of goods produced abroad and the other part is not spent at all on consumption because it is saved or used to pay taxes. It is thus understood that the multiplier will be all the higher as these leaks are low, that is to say, that the propensity to save, the tax burden and the propensity to import are low. Then, once full employment is reached, the additional public expenditure generates inflation only because of constraints on the use of production capacities of companies and wage demands that can degenerate into an explosive price-wage loop. Finally, while the multiplier is on the rise, it is also declining, with a decline in public spending leading to a more than the proportional contraction in economic activity. This last lesson, however obvious, is regularly denied in the current context.
These theses have had incredible consequences, the European Commission is indeed complacent in this perspective.
Following the outbreak of the Greek crisis in 2010, the Troika (IMF, ECB and European Commission) subjected Greece to an austerity plan that was all the more violent because it underestimated the negative effects of budgetary adjustments. about the activity. This misjudgment of the multiplier, combined with an ideological view of the effectiveness of economic policy, condemned these policies to fail. In fact, if the activity is reduced, the tax base shrinks and public expenditure increases mechanically, in particular by increasing the number of unemployed to be compensated. Faced with evidence that austerity policies were harming economic growth more than expected, the IMF (World Economic Outlook, 2012, pages 41-43) reassessed the impact of these policies, recognizing that it had underestimated multipliers and the loss of growth resulting from budgetary rigor. From this perspective, many studies have shown that multipliers are higher during a recession. These studies recall an essential lesson neglected by neoliberal orthodoxy: fiscal policy must be counter-cyclical, that is, expansionist during the recession and rigorous during periods of expansion.
Making austerity in times of crisis is more damaging to jobs and growth than the same austerity in times of prosperity. Austerity in a period already marked by the recession only amplifies this recession. On the other hand, a fiscal stimulus is more effective in times of crisis than in times of expansion and would reduce the economic and social cost of unemployment. In the end, the government must play the role of a buffer and boost the rebound when the crisis is particularly strong and it generates uncertainty such that consumption is declining and companies are perpetually postponing their investment projects. In addition, a government wishing to maximize its stimulus to the economy must not try to improve household consumption or business investment through tax cuts or reductions in social security contributions but must encourage spending by governments. public. It is indeed this type of expenditure that causes the least imports since the State has kept a significant localization of its expenditures on its territory, while households and private companies have a stronger tendency to obtain their goods. and their services abroad.  As a result of these lower import leaks, the first income cycle in the domestic economy is optimized. Similar reasoning can be led with the production of non-market services (health, education, and research). This increases GDP without these services being heavily imported (on the first round of multiplier the share of expenditure that leaks in imports are almost zero), knowing that this will contribute to a future additional demand addressed to private companies.
Given the level of activity in the euro area, governments must reactivate counter-cyclical policies, notably through public orders addressed to private companies in the energy transition sector (thermal renovation, development of alternative energies) and by the government. utilities. In addition, the euro area is a space with relatively low external imports: coordination of these stimulus policies to benefit from significant and effective multiplier effects is therefore entirely possible! Generalized austerity and supply-side policies cannot solve a deflationary demand crisis. To get out of the current crisis, it is more than necessary to rely on the simple principle of the multiplier and defend an effective and intelligent fiscal policy.