Economic theory looks at the issue of fiscal multipliers through the lens of a very academic concept called “marginal propensity to consume”.

Quite simply, after a consumer pays off their bills and buys all their essentials, any money they have left is what is called disposable income. If a consumer has disposable income, they have a choice of whether to spend it, or to save it. The proportion of their disposable income that they choose to spend is their “marginal propensity to consume” (MPC).

According to economic theory, if the MPC of a country’s population is greater than zero, then fiscal stimulus should lead to an overall gain in national income. This gain is a result of people spending portions of their stimulus checks, which hypothetically should lead to further spending in the economy.

The total amount of money that changes hands (remember that someone’s spending is another’s income) in relation to the amount of fiscal stimulus is called the fiscal multiplier. So named because the original amount of stimulus is supposed to multiply once let loose into the economy. 

If this sounds familiar, that’s because it is basically a description of how money velocity can create inflation through a dollar changing hands multiple times. 

Now, instead of debating the merits/demerits of the theoretical basis of the fiscal multiplier, let us take a different approach in trying to understand what the concept can and cannot do. (There are numerous academic papers out there if you are interested in that sort of debate)

Consider a citizen, Ben. Stimulus money is deposited into Ben’s account, and he goes out to spend all of it (i.e the best possible scenario since nothing is saved). Money circulates through the economy, and if it circulates quickly enough, inflation will rise, and along with it a rise in demand, all due to stimulus money changing hands rapidly. 

However, this is ultimately a game of musical chairs. Because money supply is not growing via loans, employers can only pay employees if consumers keep spending. That is, money has to circulate quickly enough around the system for a business to keep selling its products and then use that income to pay its employees. 

The moment the music stops and the money ceases to flow through the system, i.e. consumers start saving more than they spend; the business cannot pay its employees, and the economy is back to being in bad shape. As such, fiscal stimulus alone cannot keep an economy afloat, simply because it is a one-off injection of new money into the economy (most probably funded by governments issuing more debt). 

It is important to note that the fiscal multiplier would work if Fractional Reserve Banking (FRB) were an accurate description of how money is created. This is because every time a consumer spends stimulus money, the business that collects that money will deposit it in a bank, and under FRB, the bank can then loan it out, creating new money. But, we know that FRB does not work. Which means that fiscal stimulus does not affect the amount of loans that banks create.

Of course, what happens in reality is a lot more of a mixed bag. There will be some degree of money creation as banks are still making loans, but only to a lucky few, and different people will save/spend different amounts of the stimulus checks that they receive.

Regardless, the basic principle remains the same – the fiscal multiplier, without accompanying expansion in money supply, really cannot do more than make the hamster run faster on its wheel.