Demand-side multipliers: policy appraisal, the UK Government's Green Book and transformational projects

The new edition of the UK Government’s Green Book has introduced changes aimed at providing a fairer view on investments with long-term impacts, including climate-related and environmental projects. One part of the book that has been left largely unchanged is the section on demand-side multipliers. Stefania Cerruti and Jack Pepin-Hall argue that the Green Book should describe these multipliers in more detail, and outline the risks of inappropriately applying them to microeconomic policy appraisal.

Earlier this year, the Treasury published the 2026 edition of the Green Book, the UK Government’s handbook for policy appraisal. This new edition includes revisions that align with the Government’s aim to “support fairer and more balanced public investment decisions”.

Despite some welcome updates, one section of the book that has changed minimally since the 2022 version is the guidance on demand-side multipliers in national-level policy appraisal. Although demand-side multipliers are widely used in policy appraisal, the Green Book devotes only three paragraphs to the topic. These paragraphs explain that the macroeconomic effects of spending should not be considered as part of Green Book microeconomic appraisal, without going into the details of what these multipliers look like or how they may be misused in an appraisal.

Demand-side multipliers can be a useful tool in several economic applications, especially in macroeconomics. We contend that, as they are often employed in various types of impact assessment, the Green Book should describe them in more detail and outline the risks that may arise when they are inappropriately applied in microeconomic policy appraisal. While this is applicable to all areas of government spending, the difficulties of using these multipliers in Green Book appraisal can be particularly apparent in investments in transformational initiatives such as climate and environmental projects, due to the long-term nature and non-monetisable benefits of these investments.

What are demand-side multipliers?

Demand-side (or Keynesian) multipliers consist of factors that are applied to the inputs of a policy to estimate the additional economic activity an investment will stimulate, for example, through greater production in the supply chain and increased income from a rise in spending.

Input–output multipliers are among the most common demand-side multipliers in several different economic applications. In the UK, these multipliers are derived using input–output tables, produced by the Office for National Statistics, which document spending flows between sectors of the economy. Such flows have a natural multiplier effect. This is because suppliers of inputs for a final product must purchase more from their suppliers, who will then purchase more from their suppliers, and so on (these are ‘indirect’ effects). Additionally, money spent on inputs increases the income of these suppliers, who then purchase more goods and services (these are ‘induced’ effects).

To see how demand-side multipliers are often employed in policy appraisal, we can consider an investment in a green energy plant involving one of two intervention options: (1) building an entirely new plant or (2) retrofitting an existing facility. In this scenario, Option 1 costs £200m and Option 2 costs £100m, as the former requires larger purchases of construction materials and building services.

To calculate the benefits of each option, we consider two approaches. Firstly, if we used a simplified version of a microeconomic bottom-up appraisal, both projects could be assumed to have similar outcomes for society. In this simplified example, both reduce greenhouse gas emissions by 1 million tonnes per year. The monetary value of the investments could be calculated using the appropriate conversion factors. When comparing the derived benefits to costs, Option 2 is better value for money, as Table 1 shows.

Secondly, we could use an input–output multiplier approach. In a simplified example of how the approach could be used in policy appraisal, suppose the input–output model returned a multiplier of 1.9 for each investment. This would be applied to the cost of each policy to derive its total economic impact. Since Option 1 requires greater economic resources than Option 2, the former is estimated to have larger indirect and induced effects. Accordingly, the net present value of Option 1 is higher than that of Option 2, as Table 2 shows.

Problems with using demand-side multipliers in Green Book policy appraisal

Demand-side multipliers are covered in the “Macroeconomic Effects” section of the Green Book. The section briefly explains that macroeconomic effects should not be considered as part of a policy appraisal, because the type of investment usually covered by this sort of appraisal cannot claim to have large enough effects to be measured at a macroeconomic scale.

The section also argues that demand-side multipliers do not help distinguish between different investment options, as almost any public spending generates additional demand effects. But the section does not explain why that is the case.

The Green Book appraisal process is designed to help policymakers identify the most effective form of investment among multiple options. However, the demand-side multipliers available and used by practitioners can often be the same for similar investments within a specific sector, without providing the level of specificity usually considered in Green Book policy appraisal. While public spending will generally have positive demand-side effects that ripple through the economy, the magnitude of the effects depends on the presence of idle resources – that is, resources that will not need to be diverted away from other uses. The quantity of idle resources in the economy changes over time in ways that are difficult to predict. This uncertainty makes it challenging to select the correct magnitude of multiplier for an investment in Green Book microeconomic appraisal: any value chosen today may bear little relation to the true multiplier effect that would occur when the economic activity takes place.

Problems with using input–output multipliers in Green Book policy appraisal

The Green Book never explicitly mentions input–output multipliers, leaving implicit the fact that their use is being discouraged in the “Macroeconomic Effects” section referenced above. Given their widespread use in policy appraisal, it would be beneficial to explicitly describe the issues with employing them in microeconomic cost–benefit analysis.

As the illustrative examples above indicate, the multipliers implied by the input–output tables used in appraisals are generally at the sectoral level. This means that they risk being too generic to help practitioners estimate the effects of individual investments.

Furthermore, since input–output tables are a static snapshot of the linkages within an economy, they do not account for any supply constraints on production: an increase in spending in a sector is never assumed to divert spending or resources away from another sector; rather, it is treated as purely additional output.

Therefore, indirect and induced multipliers are closer to being a number describing the extent to which a sector is integrated with other sectors of the economy. More integrated sectors are associated with larger input–output factors. These multipliers do not capture any information about how an additional £1 of investment in a sector will be spent on other inputs, how easily other producers in the supply chain can increase their own output, or the eventual social benefits of an investment.

The lack of definitions in the Green Book goes beyond this. Input–output multipliers are typically used in Economic Impact Assessments, a distinct type of appraisal that the Green Book does not mention. These assessments are designed to estimate the effects of an investment on a particular location’s economic activity (such as GDP, gross value added or employment), typically using an input–output model to link the size of an input to its total final effect on economic activity. This is different from the type of analysis conducted in a microeconomic cost–benefit analysis, which estimates the social value of specific activities and the benefits of investments. Non-specialists might conflate Economic Impact Assessments and Green Book cost–benefit analysis, leading to miscommunication when commissioning an appraisal.

Expanding the Green Book to avoid risks to policymaking

The lack of sufficiently specific guidance in the Green Book could pose a serious risk to policymaking. While this issue may affect all types of policy appraisal, it is particularly relevant to transformational initiatives such as climate-related and environmental projects. Given that the data and other evidence required to estimate the benefits of such projects in a cost–benefit analysis can often be lacking, there is an added incentive for practitioners to rely on demand-side multipliers instead.

This could lead to several problems. Firstly, demand-side multipliers are not particularly helpful for estimating the benefits of transformational investments, such as climate-related and environmental projects. For example, the fact that an investment in the regeneration of a forest would employ many people and increase economic activity in other sectors does not necessarily speak to the fundamental value of that investment: the same people and resources could be employed in deforestation activity. To compare the relative merits of transformational projects, it is more useful to focus on the specific expected benefits of each of them.

Secondly, policy appraisals that follow Green Book guidance and avoid the use of demand-side multipliers risk being unfairly overshadowed by those that use them. This is because these multipliers mechanically increase the size of the benefits calculated for any investment.

The Treasury should consider expanding the Green Book to provide a detailed, jargon-free explanation of the challenges of using demand-side multipliers, specifying which multipliers are appropriate for different types of analysis. A detailed description of demand-side and input–output multipliers could include a technical explanation of how they work in an annex. If this is unfeasible, the Treasury could provide supplementary Green Book material or updated departmental guidance that covers these topics.

The authors would like to thank Daisy Jameson, Sini Matikainen, Tom Callahan and Georgina Kyriacou for their comments on and reviews of this commentary.