[News Glossary] Hotel Economics Theory and the Multiplier Effect...A Century-Long Debate

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The multiplier effect is often cited when discussing the impact of government fiscal spending on economic growth. Previously, as Lee Jae Myung, the Democratic Party presidential candidate, referenced the "hotel case" to illustrate how basic income and local currency could create a virtuous economic cycle, controversy arose over what was dubbed the "hotel economics theory." In response, the Democratic Party argued that Lee was simply referring to the multiplier effect.

An image posted by Lee Jae Myung, the Democratic Party presidential candidate, on his X account in 2017. Screenshot of Lee Jae Myung's X account.

The official term for the multiplier effect is the fiscal multiplier. This concept uses numerical values to express the economic growth effect of government fiscal spending: if the multiplier falls below 1, it means there is no stimulative effect on the economy; if it rises above 1, it indicates a significant stimulative effect.

The multiplier effect traces its roots to the "economic table" theory of 18th-century French economist Fran?ois Quesnay. At the time, Quesnay argued that government finances are the source of wealth. His logic was that if the government buys more grain, farmers will need to increase their harvests, which in turn creates more jobs and income.

John Maynard Keynes was the first economist to theorize and systematize the fiscal multiplier and proposed ways to overcome economic crises through active fiscal policy. Economists who later inherited his theory are called the "Keynesian school." Modernist Archive homepage

The person who theorized and systematized this logic into the fiscal multiplier was British economist John Maynard Keynes, who was active in the 1930s. Together with his student Richard Kahn and others, Keynes established a method for measuring the fiscal multiplier using mathematical models. Based on this, he completed a fiscal theory that government spending has a positive impact on corporate capital investment and production. Keynes's fiscal theory became the academic foundation for the New Deal policies in the United States during the 1930s.

Milton Friedman believed that since businesses and consumers are rational agents, government fiscal spending alone cannot drive economic growth. Scholars led by Friedman were later called the "Monetarist School" and opposed the Keynesian School. Hoover Institution

In its early days, the multiplier effect had clear limitations. Simple mathematical models could not fully account for the complexity of the real economy. Recognizing these limitations, economists conducted more detailed analyses of consumer and corporate behavior. Through this process, the so-called Monetarist School, led by Milton Friedman, emerged. The Monetarist School argued that both consumers and businesses?the core of the private economy?are "rational agents" who can anticipate their future sales and income to some extent and spend accordingly, making the limits of fiscal policy clear. Their logic was that money temporarily injected by the government during a recession is nothing more than an "unexpected windfall," so the actual effect on stimulating consumption is small.

Former President Barack Obama (right) presents a birthday cake to Lawrence Summers (left), former Chair of the Council of Economic Advisers. During the economic crisis, the economic advisors led by Chair Summers assessed the fiscal multiplier in the United States to be above 1.4, using this as the basis for an astronomical fiscal stimulus package exceeding 1,000 trillion won. White House website

The multiplier effect served as the basis for the policy responses of the United States and various European countries during the 2008 global economic crisis. During the Obama administration, White House economic advisors led by Lawrence Summers estimated the U.S. fiscal multiplier to be 1.4 and proposed a fiscal stimulus package worth $787 billion (about 1,077 trillion won). Former President Barack Obama accepted this recommendation. In contrast, the Troika (IMF, EU, ECB), which provided bailout funds to the European PIGS countries (Portugal, Italy, Greece, Spain) amid their debt crisis, made strict fiscal austerity a condition. At the time, the IMF and others assessed the fiscal multiplier in the crisis countries to be 0.5, concluding that the effects of fiscal stimulus would be limited.

Debate over the multiplier effect continues to evolve.

In 2015, five years after the European debt crisis, the European Central Bank (ECB) analyzed economic data from the PIGS countries and concluded that "the multiplier effect continues to change depending on a country's circumstances." The ECB found that the multiplier effect increases during economic downturns, making fiscal policy more effective, but if excessive fiscal spending causes the debt-to-GDP ratio to rise, the multiplier effect drops sharply. The ECB emphasized, "It is important to analyze the current debt level of a country and the medium- and long-term benefits of economic stimulus in order to keep the debt-to-GDP ratio at a sustainable level."