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REACTION PAPER 2

Fiscal Multipliers: size, determinants, and use in macroeconomic projections.

Nicoletta Batini, Luc Eyraud, Lorenzo Forni, and Anke Weber

APA Citation

Nicoletta Batini, Luc Eyraud, Lorenzo Forni, and Anke Weber (2014). Fiscal Multipliers:
size, determinants, and use in macroeconomic projections. International Monetary Fund
(IMF), Journal of Economic Literature. (IMF) (E32, E62, H50)

Research question

What are the fiscal multipliers, their size, determinants, and use in macroeconomic
projections?

Methodology

The study uses the guesstimate “bucket approach” in analysing the multipliers. The method
groups countries into different bunches called “Buckets” which are likely to have similar
multiplier values based on their observed characteristics. Also used cross-checking in cases
where countries have already estimates available. In this study, the countries were grouped as;
Advanced Economies (AEs), Emerging Markets Economies (EMEs), and Low-Income
Countries (LICs).

Variables and Data

The study uses a review of the literature method of a research study in which several studies
relating to the size, determinants of multipliers, and their use in macroeconomic projections
are analyzed. Then, the results from different researches are further analysed and classified
according to the “ Buckets” and a conclusion is drawn from each group.

Highlights

 Fiscal multipliers are defined as the ratio of the change in output to an exogenous
change in fiscal deficit ( revenue or spending) and they measure the short-term impact
of discretionary fiscal policy on output.
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 A good estimate of fiscal multipliers can play a key role in ensuring proper
macroeconomic policy planning and help economies to set fiscal targets that can also
give accurate predictions of macroeconomic adjustments to curb debt ratios.
 Because of their difficulty in estimation due to data unavailability and their reactions
to business cycles through automatic stabilizers, economists rarely use fiscal
multipliers.
 Size of fiscal multipliers:
 DSGE and SVAR models suggest that Advanced Economies (AEs) first-year
multipliers are mostly between 0 and 1 in “normal times”, with an average of
0.6 and spending multipliers are usually bigger than revenue multipliers.
However, recent studies (including the Narrative approach) have challenged
this argument and shown that multipliers can exceed 1 in “abnormal” times.
 Little is known about the size of multipliers in Emerging Market Economies
(EMEs) and Low-Income Countries (LICs). However, a few pieces of
economic literature available suggest that multipliers in these countries are
smaller than AEs due to expenditure inefficiencies in EMEs and LICs, and are
sometimes negative in the long term and in times of high public debt.
 Determinants of the size of multipliers:
 Structural characteristics: These influences the economy’s response to fiscal
shocks in normal times and they include; Trade openness, labour market
rigidities, size of automatic stabilizers, exchange rate regimes, debt levels, and
public expenditure management and revenue administration. While trade
openness, the size of automatic stabilizers, and high debt levels are negatively
correlated to the size of the fiscal multiplier, more rigid labour markets have
higher fiscal multipliers. Studies have shown that flexible exchange rate
regimes are associated with lower fiscal multipliers, unlike fixed or pegged
exchange rate regimes. Moreover, fiscal multipliers are expected to be smaller
if there are difficulties in tax revenue collection and expenditures
 Conjunctural (temporary) factors: These tend to increase or decrease
multipliers from their “normal” levels and they include the state of the business
cycle and the degree of monetary accommodation to fiscal shocks. Fiscal
multipliers tend to be larger in economic recession than in periods of economic
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boom and lower interest rates and expansionary monetary policy can cushion
contractionary fiscal policy on demand.
 Persistence of fiscal multipliers: This is distinguished from the persistence of fiscal
shocks ( which depends on whether a fiscal measure is temporary or permanent).
 The persistence of the fiscal multiplier depends on whether the fiscal shock is
permanent or temporary. Permanent fiscal measures tend to have more
persistent output effects than temporary ones. The effects of temporary fiscal
measures do not usually last longer than the duration of the shocks themselves,
otherwise, permanent measures may be more persistent.
 Business cycles also affect the persistence of fiscal multipliers and their shape
in which multipliers steadily increase if the initial fiscal shock occurs in
recession than when it occurs in the expansion
 Monetary policy. The persistence of the fiscal multiplier is high if monetary
policy does not offset the fiscal shocks ( either by increased interest rates due
to stimulative fiscal shock or an increase in money supply in response to
tightening monetary policy), otherwise fiscal multiplier may not last longer
than the duration of the fiscal shock.
 Fiscal instruments used: Permanent discretionary changes in indirect taxes,
government consumption, and transfers have short-term effects on fiscal
multipliers (vanishing within 5 fives), while a permanent discretionary change
in the public investment or corporate taxes is longer and may be permanent.

Future Research and Caveats

 The authors used a secondary research study method which may not have data quality
control as the researcher would have relied on the data processed by other researchers.
Moreover, data may be outdated which can lead to a biased conclusion.