Marginal Propensity to Import

The marginal propensity to import (MPI) is the fraction of each additional dollar of income that an economy spends on foreign goods and services. It acts as a leak in the fiscal multiplier, draining stimulus spending overseas and thereby shrinking the boost to domestic output and employment.

Why imports rise when income rises

When a government spends money — say, by building roads or raising public sector wages — households and firms receive more income. A portion of that income goes toward saving, taxes, and consumption of domestic goods. But some goes to imports. A family earning extra income may buy foreign cars, overseas travel, or imported electronics. A manufacturing firm with stronger demand might import more raw materials or components. This spending on foreign goods doesn’t generate further rounds of domestic economic activity; it stops the multiplier chain.

The MPI is “marginal” because it measures the additional import spending from additional income. If a country’s baseline import-to-GDP ratio is 20 per cent, the MPI might be only 15 per cent, meaning that most of the growth in consumption comes from domestic sources, but new spending is more import-heavy than average.

How MPI shrinks the multiplier

The standard closed-economy fiscal multiplier formula treats three main leakages: saving, taxes, and the marginal propensity to consume (MPC). In an open economy, imports form a fourth. If the MPC is 0.8 (households spend 80 per cent of after-tax income) and the MPI is 0.15 (of that spending, 15 per cent goes abroad), then only 0.68 of each new dollar actually circulates within the domestic economy. The multiplier shrinks accordingly.

For example, suppose a government injects £100 million into the economy. With an MPC of 0.8 and an MPI of 0.15, the second-round spending is £100m × 0.8 × (1 − 0.15) = £68m of domestic demand. The third round is £68m × 0.68 = £46m, and so on. The cumulative effect converges to a smaller multiplier than a closed economy would experience.

Countries with higher import shares — small, trade-dependent economies like the Netherlands or Singapore — tend to have larger MPIs and therefore smaller fiscal multipliers. Larger, more self-sufficient economies like the United States or Japan have lower MPIs and larger multipliers, all else equal.

Empirical variation and drivers

The MPI is not constant. It depends on the composition of demand, relative prices, and exchange rates. During a recession, consumers may shift toward cheaper imported goods. During a boom, they may demand more foreign luxuries. If the domestic currency appreciates, imports become cheaper and the MPI may rise. If domestic capacity constraints tighten — factories running at full tilt — firms may turn to foreign suppliers, also raising the MPI.

Developing economies often face a different pattern: they may import less as a share of baseline income (fewer imports overall) but import heavily for investment (machinery, technology) when economic activity picks up, giving them a relatively high MPI in that context.

MPI and currency regimes

Under a floating exchange rate, fiscal stimulus tends to appreciate the domestic currency as inflows of capital respond to higher interest rates and growth expectations. A stronger currency makes imports cheaper and exports dearer, which mechanically increases the MPI. This is one reason why fiscal multipliers are often smaller in floating-rate, open economies than textbook models suggest.

Under a fixed exchange rate or within a currency union (such as the eurozone), the currency channel is muted or absent. But the MPI itself may be even more consequential, because there is less offsetting appreciation to make imports expensive or boost exports. Countries inside a fixed-rate system may find that fiscal stimulus leaks more readily into imports, with less automatic stabilizer feedback.

Policy and measurement

Policymakers trying to gauge the bang for their fiscal buck must estimate the country’s MPI to forecast multipliers reliably. Central banks and finance ministries typically estimate it from historical import-income relationships or input–output tables. The estimates are rough, but critical: overestimating the multiplier (by underestimating the MPI) leads to over-confidence in stimulus, while underestimating the multiplier may cause timidity when stimulus is most needed.

The MPI also matters for international coordination. If one country’s fiscal expansion leaks heavily into imports from a trading partner, the partner benefits from higher demand but may also run a trade deficit that complicates its own macro policy. This is one reason multilateral institutions sometimes advocate for co-ordinated fiscal stimulus — it can reduce global import leakage and boost each country’s multiplier.

See also