Back Matter

Appendix I. Multiplier Estimation Techniques in the Literature

Broadly speaking, the literature relies on two main methods to derive fiscal multipliers: empirical estimation and model-based approaches. Both techniques typically report separate multipliers for revenue and expenditure measures. The empirical literature focuses mostly on the advanced G20 economies, with the largest number of studies available for the United States. Model-based fiscal multipliers from DSGEs are available for more countries. For example, the OECD regularly publishes reports that provide model-based estimates of multipliers for their membership (Barrell and others, 2012; OECD, 2009). In most studies, sector coverage is the general government.

Both methods have benefits and limitations (Box A.1.1). Empirical methods are often based on the econometric estimation of SVAR models. Their main advantage is that they use country-specific data to explore the relationship between fiscal policy and output. However, the SVAR methodology presents some limitations in the measurement of structural shocks and has been criticized. Model-based approaches, on the other hand, are based on current characteristics of the economy and describe the economic system as a whole by analyzing the interaction of many microeconomic decisions. However, multipliers coming out of DSGEs tend to be quite sensitive to the models’ characteristics.

Pros and Cons of Empirical Versus Model-Based Estimates

Empirical Estimations. Vector autoregressive (VAR) models are widely used to estimate the size of fiscal multipliers. This method is justified on the grounds that the variables of interest (revenue, spending, output, interest rate and inflation) are interrelated and there are multiple causal relationships. When estimating a VAR, the key challenge is to isolate exogenous fiscal shocks. Since the seminal paper by Blanchard and Perotti (2002), a common approach has been to use a structural identification method (also called SVAR). This method uses various identifying assumptions to extract structural shocks and estimate their impact on GDP.

SVAR models are subject to some shortcomings. First, the structural identification approach may fail to capture purely exogenous fiscal shocks, because, for example, it does not filter out asset and commodity price movements (IMF, 2010). To address this issue, recent studies have developed a “narrative” or “action-based” approach, using direct estimates of fiscal measures from government documents (e.g., budget documents) to identify exogenous fiscal shocks. There are also some attempts to combine the narrative approach and SVARs by including tax shocks derived from budget documents into the SVAR framework (Favero and Giavazzi, 2012; and Mertens and Ravn, 2012). Second, SVARs (as well as simple VARs) provide an estimate of the average response of output to exogenous fiscal shocks based on past information. If the country under study has undergone major structural changes, the “average” multiplier will not measure accurately the effect of fiscal policy on output today. Third, SVARs are generally linear and do not capture the important feature that multipliers are state-contingent. A few recent studies have addressed this issue by employing non-linear SVARs to examine whether multipliers vary across the business cycle (Auerbach and Gorodnichenko, 2012a and 2012b; Batini and others, 2012; Baum and others, 2012).

Model-based estimations. New Keynesian macroeconomic models, particularly DSGE models, are commonly used for simulating the impact of fiscal policy on growth (Coenen and others (2012) review fiscal multipliers generated in seven DSGE models). One advantage of DSGE models is that they describe the behavior of the economy as a whole by analyzing the interaction and combination of many microeconomic decisions. This is in contrast to vector autoregressive models, which look at the interactions of only a few variables.

However, analyzing fiscal multipliers with DSGE models also presents challenges. First, there is little consensus about fiscal policy modeling. For example, unlike the Taylor rule for monetary policy, there is no generally accepted fiscal rule to be included in a DSGE. Second, many DSGE models are based on linearized equations, thereby ruling out state-dependent multipliers. Third, results of simulations tend to be sensitive to the choice of certain parameters (e.g., degree of price and wage rigidities, habit persistence, investment adjustment cost, and proportion of liquidity-constrained agents). Fourth, multipliers coming out of DSGEs depend, to some extent, on the specific modeling assumptions, especially if the models are calibrated rather than estimated. When the same model is used to measure multipliers in different countries, the results tend to show less dispersion than when multipliers are estimated by empirical studies.

Choosing between alternative multiplier estimates requires assessing whether macroeconomic conditions faced by the country are “normal” by historical standards. In countries where several estimates are available, the following rule of thumb could be used: empirical studies, which usually rely on long-period estimations, are most useful to estimate multipliers under “average” or “normal” circumstances (small output gap, interest rates not constrained by the zero lower bound…), with narrative approaches generally considered as providing higher-quality estimates. If today’s circumstances differ significantly from those prevailing during the estimation period of the empirical study, model-based multipliers may be more useful, as they can reflect unusual conditions (such as a high proportion of credit-constrained agents) or conditions with few historical precedents (such as a zero lower bound on interest rates).

It is important to note that the narrative approach also presents some practical difficulties:

  • Fiscal measures are assessed against a benchmark of “unchanged policy,” which is not always clearly defined. A no-policy change scenario describes what would have happened in the absence of government interventions, but there is room for interpretation. For instance, freezing government wages is usually considered as a tightening policy but it may be considered expansionary if the assumption is that wages normally adjust to inflation and the country is experiencing a deflation period or productivity is declining.

  • If measures are announced for the future and then reversed, two or zero measures can be registered—depending on whether the initial measure is included in the new baseline.

  • The methodology used to quantify the effect of measures is not transparent and may be incorrect. Methodology may differ across countries and be influenced by data availability, as well as political decisions. Moreover, the quantification may be based on wrong macro assumptions. The yield of administrative measures is particularly difficult to assess.

  • There may also be conflicting evidence from various official sources, which would necessitate building a “consensus estimate” of the size of fiscal shocks.

Appendix II. Fiscal Multipliers by Instrument and Confidence Effect

While there is some agreement in the literature about the determinants of multipliers, there is less consensus about the size of short-term multipliers across different fiscal instruments. The discussion below summarizes some of the ongoing debate.

A. Are Multipliers Different Across Fiscal Instruments?

Macroeconomic models imply a clear hierarchy of fiscal instruments (Coenen and others, 2012; European Commission, 2010). On the spending side, investment has the highest short-term multiplier, followed by government wages and government purchases, while untargeted transfers to households are associated with the lowest output impact among spending instruments. On the revenue side, the ranking of tax instruments reflects their perceived distortionary effects. Corporate income taxes and personal income taxes have the most negative effects on GDP. Consumption taxes do relatively better (Figure A.2.1).25

Figure A.2.1.
Figure A.2.1.

Average of DSGE Models: First-year Multipliers

Citation: IMF Working Papers 2014, 093; 10.5089/9781498357999.001.A999

Note: Permanent measures, average of 7 DSGE models [Coenen and others, 2012). For the United States: average of DSGE models from Bank of Canada, EC, ECB and GIMF. For EU: average of DSGE models from EC, ECB and GIMF.

Empirically, it is more difficult to identify robust differences between instruments, but the few available studies point to a ranking of instruments quite different from the standard hierarchy. They suggest that labor income taxes are associated with larger multipliers than corporate income taxes (Table A.2.1); and that increases in consumption taxes are associated with sizeable short-term output losses. There is also no clear evidence that government investment is associated with larger multipliers than government consumption in AEs (Perotti, 2004). In emerging economies, some empirical studies (Ilzetzki and others, 2013) find that government investment is associated with positive multipliers, while discretionary changes in government consumption do not have any significant effects on output.

Table A.2.1

Empirical Studies: Short-run Multipliers by Instrument

article image

Narrative dataset on tax shocks, 1950–2006, SVAR estimation, quarterly data. Impact of 1 percentage point cut in average tax rate on real GDP per capita.

14 industrial countries, 1980–2009; quarterly database on value-added tax rate changes. Effect of one unit shock decrease in VAT revenue collection on output.

SVAR, quarterly data, 1960–2001 (West Germany up to 1989). Effect of $1 increase in spending on real GDP level.

SVAR; panel; quarterly data; unbalanced panel of 44 countries (20 high income, 24 developing); and coverage spans from as early as 1960 to 2007. Effect of $1 increase in spending on the real GDP level.

Note: PIT=personal income taxes; CIT= corporate income taxes; GC=government consumption; and GI=government investment.

B. Can Fiscal Consolidations Be Expansionary?

Before and early on in the crisis, a number of researchers and policymakers argued that positive confidence effects could dominate the adverse mechanical effects of fiscal consolidation, leading to “expansionary fiscal consolidations.” The literature on “expansionary fiscal contractions” suggests, in particular, that expenditure-based fiscal adjustments can be expansionary, even in the short term (Giavazzi and Pagano, 1990; Alesina and Perotti, 1996; and Alesina and Ardagna, 1998, 2010). This is consistent with the assumption that expenditure-based consolidation increases confidence, resulting in lower interest rates and a boost in private sector demand.

However, recent research suggests that previous findings of such expansionary effects are sensitive to how fiscal consolidation is defined (Jordà and Taylor, 2013, and Guajardo and others, 2014), and that the most famous episodes of expansionary contractions observed in Europe in the 1980s and 1990s were typically driven by external demand more than by a surge in internal private demand on the back of confidence effects (Perotti, 2012). While more evidence needs to be gathered, it does not appear that confidence effects have played a major role in the Great Recession and its aftermath.

Appendix III. Short-Term Multipliers in EMEs and LICs

Tables A.3.1 and A.3.2 report multiplier estimates from studies on EMEs and LICs. Similar tables are available in Mineshima and others (2014) for AEs.

Table A.3.1.

Empirical Studies: Short-Term Multipliers in EMEs/LICs

article image
Note: Unless otherwise noted, G denotes government investment and consumption multiplier, and T next taxes. If government consumption and investment multipliers are reported separately, we compute the simple average of the two. Short-term for most studies denotes first-year multipliers.

G denotes government investment only.

Table A.3.2

Model-based Estimates of Short-Term Multipliers in EMEs and LICs

article image
Note: Short-term refers to impact multipliers, which in DSGE models typically correspond to the first year.

Averages of expenditure (excl. transfers) and tax instruments.

Muir and Weber (2013) based on GIMF.

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1

The paper partly draws from IMF (2013). We thank Daniel Leigh for extensive discussions and comments. The paper also benefited from inputs received from Chadi Abdallah, Yasser Abdih, David Amaglobeli, Juliana Araujo, Elif Arbatli, Tamon Asonuma, Said Bakhache, Tamim Bayoumi, Martin Cerisola, Chris Erceg, Josh Felman, Lorenzo Forni, Philip Gerson, Martine Guerguil, Charleen Gust, Vikram Haksar, Dora Iakova, Deniz Igan, Martin Kaufman, Amina Lahreche, Yanliang Miao, Dirk Muir, Papa N’Diaye, Frantisek Ricka, Mike Seiferling, Vahram Stepanyan, Hajime Takizawa, Ruud Vermeulen, Bruno Versailles, and Susan Yang.

2

Nicoletta Batini: Ministry of Economy and Finance of Italy; Luc Eyraud and Anke Weber: IMF.

3

This paper refers to multipliers as one-year multipliers unless otherwise stated. In addition, all the following terms are synonyms: (exogenous) fiscal shock, fiscal impulse, and discretionary change in fiscal policy.

4

Multipliers are only one of the many factors that need to be considered in setting fiscal policy. This paper focuses on the short-term impact of fiscal measures on GDP. Short-term fiscal multipliers provide little guidance about medium- to long-term effects, and fiscal sustainability. By focusing on GDP, they are silent on other important variables, such as employment, social outcomes, and income distribution.

5

In the literature, the term “exogenous shock” refers to a change in spending or revenue that is not induced by the macroeconomic environment.

6

This has often been explained with basic Keynesian theory, which argues that tax cuts are less potent than spending increases in stimulating the economy since households may save a significant portion of the additional after-tax income.

7

The survey, based on linear VAR and DSGE models, excludes results from narrative approach studies. The list of 41 papers is provided in Mineshima and others (2014).

8

Permanent consolidations are usually associated with lower multipliers (Barrell and others, 2012).

9

According to Ilzetzki and others (2013), the low overall spending multiplier results from the combination of a government consumption multiplier of zero and a positive government investment multiplier of 0.6.

10

In the context of this paper, “structural” refers to characteristics that are intrinsic to the way the economy operates over longer time periods.

11

This argument implicitly assumes that fiscal multipliers measure the effect of planned fiscal measures on output (as in papers using a narrative approach), rather than the effect of actual changes in revenue or spending.

12

By “conjunctural” we mean due to a series of temporary, non structural, circumstances.

13

Jorda and Taylor (2013) examine how fiscal consolidation affects output distinguishing between slumps and upturns. Their measure of fiscal consolidation is based the narrative approach proposed by IMF (2010). They show that the cumulative impact of a 1 percent of GDP fiscal consolidation on real GDP is about −2.5 percent after four years in a slump compared to about 0.9 percent in a boom.

14

Results on taxes are less conclusive. Eggertson (2010) investigates the impact of labor and capital tax cuts at the zero lower bound and finds that they have contractionary effects on output (negative multiplier), in contrast to normal times when they are expansionary. He argues that this is due to their deflationary effects, which, at the ZLB, raise real interest rates.

15

In vector autoregression analysis, on the other hand, the distinction between temporary and permanent fiscal measures is not clear-cut. Although impulse response functions are based on one-off (temporary) shocks, these shocks propagate in the system’s dynamic equations, which are estimated and, therefore, reflect the persistence of past shocks.

16

As well as labor income taxes in some models.

17

This corresponds to the weighted-average value across AEs, EMEs, and LICs between 2008 and 2013. Alternative measures of openness could be used, including the more conventional ratio of exports plus imports to GDP.

18

This threshold corresponds to the weighted-average across AEs, EMEs, and LICs between 2008 and 2013. See Baunsgaard and Symansky (2009) and Fedelino and others (2009) for alternative measures of the size of automatic stabilizers.

19

Ardagna and others (2007) and Conway and Orr (2002) show that sovereign borrowing costs are much more sensitive to further changes in the debt-to-GDP ratio when public debt is above 100 percent of GDP in advanced economies. Belhocine and Dell’Erba (2013) find that the sensitivity of spreads to debt sustainability doubles as public debt increases above 45 percent of GDP in EMEs.

20

Auerbach and Gorodnichenko (2013) is one of a few empirical studies that analyze the relative importance of the structural characteristics. The authors find that labor market rigidities and the level of government debt are relatively more important than openness. Corsetti and others (2012) study how the effect of government spending varies with the economic environment in OECD countries. There are also a number of model-based papers that examine the relative weight of different factors (e.g., Barrell and others, 2012).

21

A minimum multiplier of 0 corresponds to the case of perfect Ricardian equivalence (Table 6 sets a floor of 0.1, since 0 would make the scaling exercise in Step 3 irrelevant). A maximum multiplier of 1 is consistent with: (i) the pure accounting effect of public expenditure on output; and (ii) a simple calculation of the closed-economy Keynesian multiplier for a fiscal shock equally divided between spending and revenue measures and an estimated short-term propensity to consume of 0.33 (based on U.S. estimates from Mehra, 2001).

22

It is obviously difficult to determine ex ante whether the economy has reached a cyclical trough or peak. An analysis of the amplitude and duration of past cycles may guide this assessment.

23

In the model-based literature, the effect of the ZLB on the multiplier size is usually larger than assumed here (Table 5). However this literature does not account for the fact that multipliers are also larger during downturns. Since monetary policy usually hits its effective low when the economy is in a downturn, having a larger scaling factor would lead to double counting.

24

Alternatively, an additive formula could be used in the conjunctural factors are assumed to be independent: M = MNT * (1 + Cycle +Mon).

25

Property taxes seem to be the most growth-friendly instrument (OECD 2009; OECD 2010; and EC 2010).

A Simple Method to Compute Fiscal Multipliers
Author: Nicoletta Batini, Luc Eyraud, and Anke Weber