The Other Crisis: Sovereign Distress in the Euro Area

Abstract

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.