Leakages of Multiplier

The multiplier works like a chain reaction — when someone spends money, it becomes someone else's income, and they spend it further. But in real life, not all the money keeps flowing through this chain. Some money "leaks out" at every stage. According to Prof. Peterson, a leakage is any income that is not spent on buying newly produced goods and services. The more leakages there are, the smaller the value of the multiplier.

Analogy: Think of water flowing through a pipe with holes. Each hole is a leakage. The more holes, the less water reaches the end.

According to Prof. Peterson, ‘Leakage refers to that income which is not spent for currently produced consumption goods and services may be regarded as having leaked out of income stream.’

1. Idle Savings
   When people earn extra income, they save some of it instead of spending. This saved money does not reach shops or factories, so the next round of income becomes smaller. The higher the savings rate (MPS), the weaker the multiplier. For example, if a worker earns ₹10,000 and saves ₹3,000, only ₹7,000 moves ahead in the spending chain.
2. Imports
   When people use their extra income to buy foreign goods (like an imported phone), that money goes out of the country. It creates income and jobs in the foreign country, not in ours. So the domestic multiplier gets weaker. For example, ₹4,000 spent on a Chinese product leaves India and does not help Indian workers or factories.​
3. Price Inflation
   When prices of goods rise, your extra income can buy fewer things than before. You have more money on paper, but everything costs more, so your real buying power stays almost the same. This means actual consumption does not increase much, and the multiplier effect gets reduced. This is common when the economy is near full employment.
4. Debt Cancellation
   Many people use their extra income to pay back old loans to banks or moneylenders instead of buying goods. This money goes to the bank, which may not immediately lend or spend it. So the money exits the spending chain. For example, a farmer earns ₹8,000 but uses ₹5,000 to repay a loan — only ₹3,000 enters consumption.​
5. Purchase of Old Stocks and Securities
   When people buy existing shares on the stock market, old bonds, or insurance policies, no new goods are produced. It is just money changing hands between two people. No new factory is built and no new worker is hired. It is like buying a second-hand bike — the bike company does not benefit.
6. Hoarding
   Some people keep their extra money as cash at home — in a locker, under the mattress, or in an account they never use. This money is completely "dead" — it does not go to any shop, bank, or factory. Unlike bank savings (which can be lent out), hoarded cash generates zero economic activity and simply disappears from the income stream.
7. Taxes and Corporation Savings
   Taxes reduce your disposable income at every round of the multiplier. If ₹2,000 is taken as tax from ₹10,000 income, only ₹8,000 is left for spending. Similarly, when companies pay corporate tax, less profit is available for dividends. Prof. Dillard said that taxation and corporate dividend policies directly affect the MPC and weaken the multiplier.​
8. High Liquidity Preference
   People sometimes prefer to keep extra cash in hand for daily needs, emergencies, or waiting for a better investment opportunity (Keynes called these transactionary, precautionary, and speculative motives). When people hold more cash instead of spending, less money goes into buying goods, and the multiplier effect shrinks.
9. Undistributed Profits
   Many companies do not give all their profits to shareholders as dividends. They keep a part as reserves for future expansion. This reserve money never reaches consumers, so they cannot spend it on goods and services. For example, if a company keeps ₹4 crore out of ₹10 crore profit as reserves, shareholders lose that ₹4 crore of potential spending.​
10. Excess Stocks of Consumption Goods
    If increased demand from consumers is met by selling old goods already lying in warehouses, then factories do not need to produce new goods. No new production means no new workers are hired and no new income is created. The multiplier chain pauses until old stocks run out. For example, if shops sell last year's TVs from storage, Samsung does not need to make new ones.
11. Public Investment Programmes
    When the government spends heavily, it can hurt private businesses in two ways: (a) Government projects use up workers and materials, pushing up wages and costs, making private projects too expensive. (b) Government borrowing raises interest rates, so private companies cannot afford loans. This is called "crowding out" — government spending replaces private spending, reducing the net multiplier effect.​