Quote Originally Posted by maladroit
does the multiplier effect apply to the money the government lent/gave to the banks? or was it just replacing bad money?
The multiplier effect you are referring to only applies to stimulus. A stimulus package could exist in many forms; such as tax cuts, tax rebates, infrastructure spending, etc.... Largely determined by steps 2 through infinity, spending recirculates, known as steps, until the liquidity ceases to exist. Step one was the initial stimulus package in dollar value. The multiplier depends on an economies ratio of domestic good consumption, whose multiplicative inverse is the actual multiplier only if domestic consumption is 50%.

For example, if US occupants consume 75% of their goods and services via domestic business, than their marginal propensity to consume domestic goods is 3/4. The equation for the multiplier effect is (1/(1-mpc)) hence the reciprocal of 1/4 is 4. Going even further, if a government spending stimulus equates to $1 trillion, according to Keynesian's, $4 trillion dollars worth of GDP will be created. If it is 50% (1/2), then $2 trillion dollars worth of GDP will be created.

The bailout was nothing more than a way to allow banks balance sheets to actually balance. The reason these big banks have to get loans from the Fed and other banks is so that when their reserve ratio goes below legal limit (10%), it is mandated that they either get loans via the fed, us banks, or foreign banks. Failure to do so labels you insolvent, therefore all reserves over the $100,000 (former insurance limit) would have been depleted as people ran to get their money out before it was too late. ATM's would stop paying out funds to any account in an insolvent bank, and only checking systems with solvent banks would operate. Basically, hell would break loose.