How large is the local fiscal multiplier? Evidence from Chinese counties

Abstract

The paper estimates local fiscal multipliers using annual data for 1800 China counties. The identification exploits a peculiar feature of the allocation mechanism of China's intergovernmental transfers that triggers exogenous variations on local public spending. When aggregate central-local transfers go up at the national level, National Poor Counties can receive a disproportionate amount of transfers. We therefore construct an instrument that captures this heterogeneity in the response of local public spending to national central-local transfers. The analysis points to local fiscal multipliers of approximately 0.6, which is much lower than the estimates in most previous studies. The effects of local public spending are concentrated on non-tradable industries. Finally, we find local public spending has striking effects on stimulating in-county investment, but has negligible effects on stimulating in-county consumption.