Estimating Fiscal Multipliers by Combining Statistical Identification with Potentially Endogenous Proxies

This chapter focuses on the debate over the size of fiscal multipliers, which measure the impact of fiscal policy on output. The Great Recession has refocused attention on the effectiveness of fiscal policy multipliers, and there seems to be broad agreement that expansionary fiscal policy has a positive impact on growth, at least in the short term. However, it is unclear whether fiscal multipliers are larger or smaller than unity. Based on a comprehensive review of the literature, the chapter concludes that the size of first-year government spending multipliers lies between 0.3 and 1.0 during normal times, with revenue multipliers being significantly smaller. The size of multipliers tends to be influenced by a variety of factors, however, including the state of the economy, monetary policy stance, degree of trade openness, automatic stabilizers, and types of fiscal instruments used. In particular, multipliers could be significantly larger during economic downturns than during economic expansions. The finding has important policy implications for the design of fiscal adjustment plans.

The effectiveness of fiscal policy in smoothing the impact of shocks depends critically on the size of fiscal multipliers. This is particularly relevant for the GCC countries given the need for fiscal policy to cushion the economy from large terms of trade shocks in the absence of an independent monetary policy and where fiscal multipliers could be weak dues to substantial leakages through remittances and imports. The paper provides estimates of the size of fiscal multipliers using a variety of models. The focus is on government spending since tax revenues are small. The long-run multiplier estimates vary in the 0.3-0.7 range for current expenditure and 0.6-1.1 for capital spending, depending on the particular specification and estimation method chosen. These estimates fall within the range of fiscal multiplier estimates in the literature for non-oil emerging markets.

The aim of this paper is to estimate government consumption multiplier and to examine the effect of various characteristics of countries on the size of fiscal multiplier. We apply a panel VAR model following Ilzetzki et al. (2013) for a sample of 28 EU countries covering the period from 1995 to 2017. Key findings are, first, the estimated average fiscal multiplier is larger than unity. Second, the size of fiscal multiplier is larger in the cases of lower public indebtedness, for more developed European countries and for more financially open economies, which is also in line with relevant empirical literature. Regarding the role of trade openness, the results are inconclusive. In addition to this, membership of countries in the European integrations positively affects the size of fiscal multiplier. Therefore, fiscal policymakers should use fiscal stimuli as the instrument of boosting short-term economic growth selectively and consider country-specific characteristics. This paper contributes to the ongoing discussion in two ways, it examines the effect of additional characteristics of countries on the size of fiscal multiplier and updates existing empirical literature.

Empirical literature explains the heterogeneity of fiscal multiplier estimates through the analysis of various cyclical and structural determinants of economies, with economic inequality, as one of the key structural characteristics, receiving relatively little attention so far. In this study, using a wide sample of countries and applying the vector autoregression methodology, we first estimated fiscal multipliers and the impact of fiscal stimuli on the dynamics of the price level. The findings indicate that the estimated fiscal multipliers are mostly positive, and fiscal stimuli tend to produce an inflationary effect. Subsequently, we examined the variability in the size of fiscal multipliers in relation to various indicators of income and wealth inequality. The key findings of this study reveal that as economic inequality increases, particularly in the context of income disparities, the size of fiscal multipliers also rises. This insight is particularly important for policymakers in designing appropriate fiscal measures in an evolving macroeconomic environment.

This paper asks whether increases in government spending stimulate private activity. The first part of the paper studies private spending. Using a variety of identification methods and samples, I find that in most cases private spending falls significantly in response to an increase in government spending. These results imply that the average GDP multiplier lies below unity. In order to determine whether concurrent increases in tax rates dampen the spending multiplier, I use two different methods to adjust for tax effects. Neither method suggests significant effects of current tax rate changes on the spending multiplier. In the second part of the paper, I explore the effects of government spending on labor markets. I find that increases in government spending lower unemployment. Most specifications and samples imply, however, that virtually all of the effect is through an increase in government employment, not private employment. I thus conclude that on balance government spending does not appear to stimulate private activity.

This article explores a natural connection between fiscal multipliers and foreign holdings of public debt. Although fiscal expansions can raise domestic economic activity through various channels, they can also have crowding-out effects if the resources used to acquire public debt reduce domestic consumption and investment. These crowding-out effects are likely to be weaker when governments have access to foreign savings when selling their debt, leading to larger fiscal multipliers. We test this hypothesis for the U.S. in the post-war period and for a panel of 17 advanced economies from the 1980s to the present. To do so, we assemble a novel database of public debt holdings by domestic and foreign creditors for these countries. We combine these data with standard measures of fiscal policy shocks and show that, indeed, the size of fiscal multipliers is increasing in the share of public debt held by foreigners. In particular, the fiscal multiplier is smaller than one when the foreign share is low, such as in the U.S. in the 1950s and 1960s and Japan today, and larger than one when the foreign share is high, such as in the U.S. and several European countries today.

The fiscal multiplier represents the ratio of the change in national income to an associated increase in government spending. Fiscal multiplier effects are commonly estimated to justify options for government spending. Multiplier effects are not considered in economic evaluations of healthcare, but alternate forms of healthcare spending are expected to have varying multiplier effects. This paper describes the estimation and application of net government spending multiplier effects to two published economic evaluations. Negative net multiplier effects are estimated for an evaluated pharmaceutical for the treatment of stable cardiovascular disease, with a resulting increase in the published incremental cost per quality-adjusted life-year (QALY) gained from AU$31,244 to 47,311. Positive net multiplier effects are estimated for an evaluated healthcare delivery model for frail older people, with a resulting decrease in the published incremental cost per QALY gained from AU$8129 to 7669. The inclusion of net multiplier effects in economic evaluations undertaken from a societal perspective can have important effects on the estimated value of evaluated health technologies and services. The potential for government spending on healthcare to crowd out existing spending is considered low, but further investigation of crowding-out effects is warranted.

This paper explores a natural connection between fiscal multipliers and foreign holdings of public debt. Although fiscal expansions can raise domestic economic activity through various channels, they can also have crowding-out effects if the resources used to acquire public debt reduce domestic consumption and investment. These crowding-out effects are likely to be weaker when governments have access to foreign markets to place their debt, increasing the size of multipliers. We test this hypothesis on (i) post-war US data and (ii) data for a panel of 17 advanced economies from the 1980's to the present. To do so, we assemble a novel database of public debt holdings by domestic and foreign creditors for a large set of advanced economies. We combine this data with standard measures of fiscal policy shocks and show that, indeed, the size of fiscal multipliers is increasing in the share of public debt held by foreigners. In particular, the fiscal multiplier is smaller than one when the foreign share is low, such as in the U.S. in the 1950's and 1960's and Japan today, and larger than one when the foreign share is high, such as in the U.S. and Ireland today.

This paper evaluates the effectiveness of fiscal policy by employing a structural panel vector autoregression model with a shock to fiscal spending identified via theoretical robust sign restrictions. Using an annual data set of 120 countries over the period 1960-2014, the results show that fiscal multipliers are larger in advanced economies, when public debt is low, at a high level of financial development, in a financial crisis, and during business cycle downturns. Contrary to conventional wisdom, fiscal multipliers are not necessarily smaller in countries that are relatively open to trade and capital flows and operating under flexible exchange rate regimes. The relationship between the size of fiscal multipliers and the three dimensions of openness-trade openness, capital mobility, and exchange rate flexibility-hinges on the response of the real exchange rate and the domestic monetary policy pursued.

This paper explores a natural connection between fiscal multipliers and foreign holdings of public debt. Although fiscal expansions can raise domestic economic activity through various channels, they can also have crowding-out effects if the resources used to acquire public debt reduce domestic consumption and investment. These crowding-out effects are likely to be weaker when governments have access to foreign markets to place their debt, increasing the size of multipliers. We test this hypothesis on (i) post-war US data and (ii) data for a panel of 17 advanced economies from the 1980's to the present. To do so, we assemble a novel database of public debt holdings by domestic and foreign creditors for a large set of advanced economies. We combine this data with standard measures of fiscal policy shocks and show that, indeed, the size of fiscal multipliers is increasing in the share of public debt held by foreigners. In particular, the fiscal multiplier is smaller than one when the foreign share is low, such as in the U.S. in the 1950's and 1960's and Japan today, and larger than one when the foreign share is high, such as in the U.S. and Ireland today. JEL Classification: E62, F32, F34, F36, F41, F62, F65, G15, H63

In a pioneering article in this Journal, Zahn [22] investigated the separate and combined influences of increase in government spending and government borrowing on the time path of income. The investigation was undertaken within the framework of a small quarterly model of the U.S. economy consisting of both commodity and financial (flow of funds) sectors. By explicitly using government borrowing, Zahn tested the crowding out hypothesis as one involving both government spending and borrowing effects on the flow of funds between commodity and financial markets. The combination of both the expansionary influences of government spending and contractionary influences of government borrowing on the time path of income determine the extent of real crowding out. Zahn distinguishes between pure and partial multipliers. The influence of an increase in government spending, financed strictly by an increase in government borrowing, is measured by the pure multipliers. They are based on the assumption that increases in endogenous net taxes as a result of an expansionary fiscal policy are held in a Treasury account and offset in the government budget constraint by equal decreases in the monetary base. On the other hand, the influence of an increase in government spending, financed in part by endogenous net taxes and the remainder by government borrowing, is measured by the partial multipliers. The major results in Zahn [22] may be summarized as follows. The pure multipliers show that the greatest influence of an increase in government spending, financed strictly by borrowing, is registered during the first two quarters but afterwards crowding out occurs. The partial multipliers show similar results, but crowding out is substantially less because borrowing requirements are reduced. Lastly, the cumulative multipliers indicate that a sustained increase in government spending, financed either by borrowing or by both endogenous net taxes and borrowing, increases income during the sample period, but at a decreasing rate, and after many years the influence falls to zero. In other words, crowding out occurs as a result of the negative sign of the government borrowing multipliers, but it is not large enough to outweigh the expansionary influence of government spending except in the very long run, when the steady state government spending multiplier approaches zero. Zahn's conclusions are, in principle, compatible with those found in most previous and

The past several years of recession and slow recovery have raised much interest on the effect of fiscal stimulus on economic activity, even as high public debts in many countries would call for fiscal consolidation. To evaluate the delicate balance between stimulus and consolidation requires measuring the size of fiscal multipliers, which often depends on having quarterly data so that exogenous fiscal policy shocks can be identified. We estimate fiscal multipliers using a novel methodology for identifying fiscal shocks within a structural vector autoregressive approach using annual data while controling for debt feedback effects. The estimation focuses on regions with scarce quarterly data (mostly low-income countries), and uses results for advanced economies, emerging market countries, and other broad groupings for which alternative estimates are available to validate the methodology. Differently from advanced and emerging market economies, fiscal consolidation in low-income countries has only a small temporary negative effect on growth while raising medium-term output. Shifting the composition of public spending toward capital expenditure further supports long-run growth

In this paper, we develop an endogenous growth model with market regulations on explicitly modeled financial intermediaries to examine the effects of alternative government financing schemes on growth, inflation, and welfare. In the presence of binding regulation, there is always a unique equilibrium. We perform four alternative policy experiments; a change in the seigniorage tax rate, a change in the seigniorage tax base, a change in the income tax and a change in the fiscal-monetary policy mix. We find that in the presence of binding legal reserve requirements, a marginal increase in government spending need not result in a reduction in the rate of economic growth if it is financed with an increase in the seigniorage tax rate. Raising the seigniorage tax base by means of an increase in the reserve requirement retards growth and it has an ambiguous effect on inflation. An increase in income tax financed government spending also suppresses growth and raises inflation although not to the extent that the required seigniorage tax rate alternative would. Switching from seigniorage to income taxation as a source of government finance is growth reducing but deflationary. From a welfare perspective, the least distortionary way of financing an increase in the government spending requirements is by means of a marginal increase in the seigniorage tax rate. Under the specification of logarithmic preferences, the optimal tax structure is indeterminate.

This paper proposes a DSGE model for the Russian economy with a new specification in which the utility function of Ricardian households is described using Jaimovich-Rebelo preferences to reduce the impact of the income effect on labor supply. Along with Ricardian households, the model also considers non-Ricardian households that consume all their current income. The DSGE model depicts a small open economy that consists of two production sectors: domestic and export. The model is realistically calibrated and provides a qualitative analysis of differences in fiscal multipliers under varying conditions for the economy’s functioning in order to identify the impact of different versions of the utility function on the transmission of fiscal policy. Further econometric assessment of the model’s parameters would be required to obtain more accurate estimates of the fiscal multipliers. The conclusion is that, under free flow of capital, government spending on final consumption of goods and services results in multipliers greater than one if the increase in government spending is short-term (1 to 2 quarters), or if the central bank responds to a fiscal shock with monetary stimulus. For public investment and transfers, the multipliers are systematically less than one because much of this expenditure is spent on imports. With strict limits on the movement of capital, the situation changes dramatically; the multipliers for all the types of government spending considered when an increase in it is sustained for one year comes to about 1.5. However, a strong GDP response to government spending shocks typically has serious inflationary consequences. Therefore, the high inflation and rapid recovery of GDP with some signs of overheating observed in recent years can be qualitatively attributed to an expansive fiscal policy in the presence of restrictions on the movement of capital.

Fiscal multipliers in the euro area: A comparative study⋆