Fiscal Multipliers – How big or small?
Tyler Cowen points to an interesting paper by Ethan Ilzetzki, Enrique Mendoza, and Carlos Vegh. There are multiple options to read the paper:
Here is a new paper (gated) on fiscal multipliers (shorter, ungated version here, powerpoints here, slides here, ungated but slightly older version here)
I read the ungated shorter version (:-)). The authors look at fiscal multipliers across 45 countries (20 developed and 25 developing) and divide these economies further into different types. The findings are:
- In high income countries, the impact response of output to increases in government spending is larger than in developing countries and considerably more persistent.
- The degree of exchange rate flexibility is a critical determinant of the size of fiscal multipliers. Economies operating under predetermined exchange rate regimes have long-run multipliers of around 1.5, but economies with flexible exchange rate regimes have essentially zero multipliers.
- The degree of openness to trade (measured as exports plus imports as a proportion of GDP) is another critical determinant. Relatively closed economies have long-run multipliers of around 1.6, but relatively open economies have very small or zero multipliers.
- In highly-indebted countries, the output response to increases in government spending is short-lived and much less persistent than in countries with a low debt to GDP ratio.
- The multipliers for the United States in the post-1980 period are rather small (in the range 0.3-0.4) both in the short and long-run. On the other hand, multipliers for government investment are large (around 2).
What are the implications for policy?
All in all, our findings suggest that drawing sweeping generalizations on the size of the fiscal multipliers is probably an exercise in futility. Some of our most robust results point to the fact that the size of the fiscal multipliers critically depends on key characteristics of the economy (closed versus open, predetermined versus flexible exchange rate regimes, high versus low debt) or on the type of aggregate being considered (government consumption versus government investment).
In particular, we have found that, in economies open to trade and operating under flexible exchange rates, a fiscal expansion leads to no significant output gains. Further, any gains will be, at best, short-lived in highly-indebted countries. Since, over the last decades, many emerging countries have become more open to trade and moved towards greater exchange rate flexibility (typically in the context of inflation targeting regimes), our results suggest that seeking the holy grail of fiscal stimulus is likely to be counterproductive, with little benefit in terms of output and potential long-run costs due to larger stocks of public debt.
On the other hand, emerging countries – particularly large economies with some degree of “fear of floating” – would be well served if they stopped pursuing procyclical fiscal policies. Indeed, emerging countries have typically increased government consumption in good times and reduced it in bad times, thus amplifying the underlying business cycle – what Kaminsky, Reinhart, and Vegh (2004) have dubbed the “when it rains, it pours” phenomenon. The inability to save in good times greatly increases the probability that bad times will turn into a full-fledged fiscal crisis. Given this less than stellar record in fiscal policy, even an a-cyclical fiscal policy – whereby government consumption and tax rates do not respond to the business cycle – would represent a major improvement in macroeconomic policy. While occasional rain may be unavoidable for emerging countries, significant downpours would be relegated to the past.
Interesting paper. Helps think through the fiscal multiplier debate more clearly. And the conclusion is pretty intuitive as well. The size and effectiveness of fiscal multiplier depends on nature of economy.
mostlyeconomics.wordpress.com
...A remarkable example of the disagreement among economists regarding the size of the fiscal multiplier for government spending occurred in early 2009. In assessing the likely impact of President Obama’s $787 billion stimulus program on the U.S. economy, economist Robert Barro argued that the peacetime multiplier was essentially zero. That is, each additional dollar of government spending would displace or “crowd out” exactly one dollar’s worth of private consumption and investment, resulting in a negligible effect on employment. In sharp contrast, Christina Romer, then Chair of President Obama’s Council of Economic Advisers, argued that a multiplier of 1.6 should be used in estimating the new jobs that would be created by the stimulus program. This sharp difference between Barro’s and Romer’s multiplier estimates translated into an enormous disparity of 3.7 million new jobs, the number which Romer notoriously claimed would be generated by the stimulus package by the end of 2010.In an IMF Working Paper entitled How Big (Small?) Are Fiscal Multipliers? published in 2011, co-authors Ethan Ilzet, Enrique G. Mendoza and Carlos A. Vegh attempt to more precisely measure the size of fiscal multipliers. Ilzet et al. use a new and unique data set to statistically estimate government spending multipliers for countries sorted according to several “key characteristics” of the policy regime under which fiscal policy may be conducted. While most studies use annual data or quarterly data interpolated from annual data, Ilzet et al. use only data that have been originally collected on a quarterly basis. The study takes a sample of 44 countries comprising 20 high-income and 24 developing countries and covers a period from the first quarter of 1960 to the fourth quarter of 2007, although the extent of the coverage varies across countries.
The most significant findings of the study, especially as they relate to the key characteristics of the U.S. economy, are very interesting. The “impact” multiplier for high-income countries is 0.37, which is to say that one added dollar of government spending is associated with only 37 cents of additional output in the quarter in which it is undertaken. But since fiscal stimulus packages are usually implemented over time, it is the “cumulative” or long-run multiplier that is more relevant because it accounts for the full effect of the fiscal expansion. For high income countries the cumulative multiplier is estimated at 0.80 over 20 quarters. Thus even in the long run, 20 cents of private output (consumption plus investment plus net exports) is crowded out by each dollar of government spending that accrues to GDP...
mises.org
For the US, we find the impact multiplier is 0.64 and the long-run cumulative multiplier is 1.19. While these estimates are certainly closer to Romer’s than to Barro’s, they mask some important structural changes over the sample period. When estimating the multipliers for the pre-1980 period, we get considerably larger numbers than the post-1980 multipliers. The post-1980 multipliers are just 0.32 on impact and 0.4 in the long-run. This is certainly a far cry from the impact multiplier (1.05) and long-run multiplier (1.55) used in the Romer report.
voxeu.org |
