## wpiea2019072

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### Key facts and motivation
- Average government debt of small states rose from about 50 percent of GDP before the global financial crisis to about 60 percent of GDP in 2019.
- Both domestic and external government debt rose, with external debt contributing more to the rise in overall debt.
- Government expenditures sharply increased after the 2007-09 global financial crisis; spending growth continued in response to commodity prices, natural disasters, and exchange rate depreciations.
- Increase in government spending concentrated in current spending; capital spending remained modest.
- Many small states face small populations, narrow production bases, limited diversification, limited economic scales, geographic remoteness, and proneness to climate change and natural disasters—factors that may lower fiscal multipliers via higher import shares of GDP and higher risk premia.

### Research objective and contribution
- Objective:
  - Estimate fiscal policy multipliers—the impact of fiscal policy on GDP—for small states.
- Contribution:
  - Uses two distinct models: an empirical forecast-error/local-projection approach and a DSGE-type (GIMF) model calibrated to a hypothetical small open economy.
  - Empirical sample larger than prior studies: main sample 23 small states; robustness sample 34 small states per World Bank definition.
  - Empirical innovations: local projection method (Jorda, 2005), forecast error approach using WEO vintages to mitigate foresight, and augmentation to include future fiscal shocks (per Teulings and Zubanov, 2014).

### Empirical approach and identification
- Baseline local projection specification (equation (1)) estimates GDP growth impacts of unanticipated fiscal shocks over horizons h using:
  - Country fixed effects (α_j), time fixed effects (γ_t).
  - Fiscal shock terms for government investment (I) and government current primary spending (C).
  - Control set X includes two lags of GDP growth, fiscal variables in levels as percent of GDP, cumulative future fiscal shocks between t+1 and t+h, and a natural disaster damage variable as percent of GDP.
- Forecast-error identification:
  - Fiscal shock FShock_j,t^k = actual (from October WEO of following year) minus forecast (from October WEO of that year), with fiscal variables scaled by previous year’s GDP.
  - Using October WEO vintages mitigates anticipation effects and reduces contemporaneous endogeneity within final quarter (October–December) of the year.
  - Robustness check: controlling for tax revenues; results are robust.

### Data
- Annual data for 1990-2017 from IMF WEO vintages.
- Main small-state sample: IMF definition (34 countries); empirical sample restricted to 23 countries after excluding cases for insufficient or unreliable data and extreme variance.
  - Final 23 countries: 5 from Africa, 6 from Asia, 11 from the Caribbean, and 1 from Europe.
- Series definitions:
  - Real GDP growth: October 2018 WEO, series ngdp_r.
  - Government investment: series gcek prior to 2010 and ggaan_t after 2010.
  - Government current primary spending: gcec prior to 2000 and total general government expense gge after subtracting interest payment ggei thereafter.
- Natural disaster damage data: EM-DAT.

### Empirical results (baseline and patterns)
- Medium-term multipliers:
  - Government current primary spending multipliers: around zero (medium term).
  - Government investment multipliers: closer to 1 (medium term).
  - Medium-term tax multipliers: estimated at a fraction of medium-term government investment multipliers.
- Short-run (impact) multipliers:
  - Empirical model: government current primary spending impact multiplier ≈ 0.4.
  - GIMF model: government current primary spending impact multiplier ≈ 0.6.
- Detailed baseline empirical patterns:
  - A +1 percent of GDP increase in government current primary spending:
    - Increases output by about 0.3 percent on impact (year 1).
    - Peaks in year 2 at around 0.4 percent.
    - Declines over time to zero (no prolonged medium-term effect).
  - Government investment:
    - Small effect on GDP at impact.
    - Relatively large and positive medium-term effect (example: about 0.2 percent of GDP in year 2 as reported in the text).
- Summary from Figure 8:
  - Government current primary spending: short-term impact multiplier around 0.3; negligible medium-term impact.
  - Government investment: small impact multiplier; relatively large medium-term multiplier around 0.9 on output by fourth year.

### Expansion vs Consolidation (nonlinear episodes)
- Specification separates fiscal shocks into positive (expansionary) and negative (consolidation) episodes via equation (3).
- Empirical findings:
  - Government current primary spending multiplier for expansion episodes is smaller than for consolidation episodes.
  - When government increases current primary spending, it does not boost GDP by much at impact nor in the medium term.
  - When government reduces government current primary spending:
    - negative impact of around 0.4 percent on GDP at impact;
    - negative impact of 0.8 percent at the peak after one year.

### Recession vs Boom multipliers
- Smooth transition function G(zi,t) = exp(−γzi,t) / (1+exp(−γzi,t)), γ>0, with zi,t GDP growth rate normalized to zero mean and unit variance; γ set to 1.5.
- Empirical findings:
  - Government current primary spending multiplier: 0.6 on impact during recessions; no notable effect during booms.
  - Government investment multiplier: around 0.8 on impact during recessions; negative fiscal multiplier during booms.

### Robustness checks
- Battery of robustness checks (Table A3, A4) includes:
  - Country & time fixed effects only; adding lagged variables; controlling for natural disasters; controlling for future fiscal shocks; controlling for terms of trade, net exports, government tax, government revenue.
  - Separate regressions for government current primary spending and government investment.
  - Changing sample definition from IMF’s small states to WB’s small states increases sample from 23 to 34; qualitative results hold.
  - Results robust to changes in control variables and outlier thresholds, using trend GDP instead of actual GDP to divide variables, and using previous year’s WEO data instead of current year’s to obtain fiscal variable forecast.
- World Bank sample (34 countries) results:
  - Impact multiplier for government current primary spending was 0.2 and 0 for government current primary spending compared to baseline multipliers of 0.3.
  - Government investment five-year multiplier 0.6 for larger sample compared to baseline 0.9.
- Estimations for initially highly-indebted countries (government debt > 70 percent of GDP) yield coefficients similar to baseline.

### GIMF model and calibration (hypothetical small state)
- Model: IMF’s Global Integrated Monetary and Fiscal (GIMF) model — open-economy DSGE where Ricardian equivalence does not hold; overlapping-generation agents with finite lifetimes; some liquidity constrained.
- Key model features: consumer habits, investment adjustment costs, import adjustment costs, productive public infrastructure spending that adds to public capital stock and enhances productivity.
- 3-economy calibration: hypothetical small state, the United States, and aggregate rest of world.
- Hypothetical small state calibration values and assumptions (steady state; each period = one year):
  - Population share of small state: 0.001 percent of world GDP.
  - Real GDP growth rate (percent; annual): 1.5
  - Inflation rate (percent; annual): 7.0
  - Real gross interest rate (percent; annual): 4.0
  - Population growth rate (percent; annual): 1.0
  - Share of liquidity-constrained agents (percent): 50.0
  - Fiscal ratios (percent of GDP):
    - Government Consumption to GDP: 20.0
    - Public investment to GDP: 4.7
    - Tax revenue to GDP: 22.5
      - Consumption taxes: 7.5
      - Capital taxes: 4.0
      - Labor taxes: 8.0
      - Lump sum taxes: 3.0
    - Government Debt: 61.0
  - Imports (percent of GDP): 61.0
  - Labor Shares (percent): 55.0
  - Labor Share; nontradables (percent): 60.0
  - Investment Share (percent): 17.2
  - Population Share in the World; small state (percent)*: 0.0
  - Population Share in the World; U.S. (percent): 23.0
  - Population Share in the World; rest of the world (percent): 77.0
  - Households planning horizon: 15 years (probability of death 6.7 percent per year).
  - Decline in lifecycle worker productivity: 5 percent per year.
  - Half of small state’s households are liquidity-constrained (50.0 percent).
- Small state initial levels for both imports and government debt set at 61 percent of GDP (2017 average for sample).

### GIMF model results — baseline multipliers and time profiles
- Baseline scenario: permanent public-debt-reducing shocks that reduce overall fiscal deficit permanently by 1 percent of GDP; assume no monetary policy reaction.
- Five-year baseline fiscal multipliers (effects on level of GDP after five years):
  - Government current primary spending multiplier: almost zero after five years.
  - Government investment multiplier (five-year): around 0.6 (permanent reduction in investment by 1 percent of GDP implies cumulative loss of 0.6 percent of GDP over five years).
- Five-year multipliers of consolidation through increasing taxes:
  - Consumption taxes: about 0
  - Labor taxes: 0.4
  - Capital taxes: 0.6
- Time profile (Table 3):
  - Multipliers relatively larger at impact and decrease thereafter in many cases.
  - Where consolidation affects capital stock (government investment and taxes on capital), multipliers increase again over the medium term until reaching steady state levels.
  - In other cases, multipliers fall through the medium term and beyond until they reach zero.

### Dynamics of consolidation via lower government consumption (GIMF)
- Shock: permanently lower overall fiscal deficit by 1 percent of GDP via reduced government consumption.
- Fiscal dynamics:
  - Government consumption lowered; government investment and transfers remain virtually unchanged compared with baseline.
  - Government debt falls on a declining trend compared to baseline.
  - Government interest expenditures decrease over time as debt falls; primary fiscal balance improves over time.
- Macroeconomic dynamics:
  - Impact multiplier of government consumption consolidation shock: about 0.6 at impact.
  - Multiplier shrinks over time, reaching around 0 after about four years.
  - At impact, private consumption and investment decline as public jobs and government contracts are lost; they gradually return to fundamentals as primary balance improves.
  - Consolidation lowers inflation; with nominal exchange rate broadly unchanged, real exchange rate depreciates, boosting exports and lowering imports; imports dampen more at impact due to simultaneous declines in government and private demand and partially recover as private demand improves.

### Permanent consolidation via lower government investment — dynamics and quantitative impacts
- Shock: permanently lower overall fiscal balance by 1 percent of GDP through government investment.
- Key short- and medium-term effects (reported contributions and dynamics):
  - Total impact on GDP at impact: -0.6 percent (contribution to the level of GDP).
  - Government spending contributions across periods include values such as -1.1, -1.0, -0.9, -0.8, -0.7, -0.6 (percent contributions displayed in figures).
  - Net exports contribution examples: 0.9, 1.0, 1.0, 0.9, 0.7, 0.6.
  - Exports contribution examples: 0.1, 0.2, 0.3, 0.3, 0.2.
  - Imports contribution examples: -0.8, -0.8, -0.7, -0.6, -0.5, -0.4.
  - Private consumption and private investment decline at impact (examples: private consumption around -0.2 to -0.1; private investment around -0.1).
- Mechanisms and persistence:
  - Immediate negative effect on private consumption and investment as consumers lose public jobs and businesses lose government contracts.
  - Over time private consumption and investment recover but settle at lower steady-state levels because lower government investment permanently depresses capital stock and production.
  - Consolidation lowers inflation and depreciates the real exchange rate, improving trade balance via higher exports and lower imports; as private demand recovers imports partly increase.
  - Decline in government investment produces a more lasting output reduction than a comparable decline in government consumption; in the very long term (well beyond 20 years) output effect returns to zero as private investment eventually replaces lost public investment.
- Fiscal variables behavior:
  - Government debt declines over time due to permanently lowered fiscal deficit.
  - Primary fiscal balance improves over time concomitant with lower government debt.
  - Interest expenditures and other fiscal components adjust as shown in model charts (percent deviations from steady state).

### Primary, temporary, and disaster-related multipliers
- Primary multipliers:
  - Primary multipliers are larger than baseline multipliers because primary multipliers hold the primary balance unchanged while baseline assumes falling interest expenditures and improving primary balance.
- Temporary multipliers:
  - Temporary shock: reduce overall deficit in the first year by 1 percent of GDP and return to steady state the following year.
  - Temporary multipliers are notably smaller than baseline (permanent) multipliers; some temporary multipliers may show "wrong" signs due to small sizes and model dynamics.
- Multipliers following natural disasters:
  - Natural disaster assumed to destroy 10 percent of GDP in initial period; fiscal policy implemented thereafter.
  - Five-year cumulative GDP impacts:
    - Government consumption post-disaster: medium-term multiplier close to 0.4 (notably larger than baseline).
    - Government investment post-disaster: medium-term multiplier estimated at 0.7 (slightly larger than baseline).
  - Interpretation: larger multipliers when there is slack in the economy; aligns with empirical findings of larger multipliers in recessions compared to booms.

### Sensitivity analysis — country characteristics
- Imports share:
  - Range analyzed: 30 to 80 percent of GDP.
  - Finding: higher imports share → lower fiscal multipliers (greater trade leakage) for impact (one-year) and medium term (five-year).
- Government debt level:
  - Range analyzed: 20 to 120 percent of GDP.
  - Finding: higher government debt level → higher fiscal multipliers. Rationale: consolidation lowers the risk premium more for higher-debt countries, yielding larger benefits.
- Share of liquidity-constrained households:
  - Range analyzed: 20 to 60 percent of population.
  - Finding: larger share of liquidity-constrained households → larger fiscal multipliers, because hand-to-mouth behavior raises marginal propensity to consume.

### Comparisons with previous studies and literature
- Empirical and model comparisons:
  - This study (Empirical, 23 small states): Government Consumption On Impact: 0.27-0.39*; Government Consumption Medium Term: -0.12; Government Investment On Impact: 0.10-0.26*; Government Investment Medium Term: 0.88-1.06*.
  - This study (34 small states, World Bank): Government Consumption On Impact: 0.16*; Government Consumption Medium Term: -0.11; Government Investment On Impact: 0.1-0.20*; Government Investment Medium Term: 0.61-0.84*.
  - GIMF (hypothetical small state): Government Consumption On Impact: 0.58*; Government Consumption Medium Term: 0.05*; Government Investment On Impact: 0.68*; Government Investment Medium Term: 0.57*; Tax On Impact: -0.36*; Tax Medium Term: -0.01.
- Literature context:
  - SVAR and narrative studies for small states report small to moderate multipliers (examples preserved in Table A5).
  - Broader LAC studies find multipliers between 0.5 and 1.1 with government consumption impact ~0.2 and government investment impact ~0.6 on impact and 1.1 after a year.
  - Literature review (Batini et al., 2014) reports fiscal multipliers for low-income and emerging economies generally low at around 0.2 to 1.3 with many panel studies around 0.2-0.5 on impact.

### Policy implications and recommendations
- Main conclusions:
  - Government consumption has medium-term fiscal multiplier about zero on level of GDP; government investment has a multiplier around 0.6-1.1.
  - Short-term (impact) multipliers for government consumption and investment are around ½.
  - Government investment affects potential GDP in small states more than government consumption.
- Policy recommendations:
  - For small states with large debt, fiscal consolidation is necessary to place public finances on a sustainable path and build fiscal space; policymakers should weigh potential GDP costs.
  - Consolidation via reductions in current primary spending may have limited persistent output costs relative to cuts in investment.
  - Protecting or prioritizing public investment can yield larger medium-term GDP benefits; a consolidation plan that includes expansion of government investment within the overall consolidation envelope can be growth friendly.
  - Design of consolidation or stimulus should consider country-specific features that affect multipliers (import openness, debt level, business-cycle position, prevalence of natural disasters).
- Caveats and areas for future work:
  - Results may depend on how government spending is financed; GIMF assumes financing by surplus/deficit, empirical part does not consider financing sources.
  - Higher public investment financed by debt may not be desirable if returns do not offset interest on domestic and external loans.
  - Political difficulty and distributional impacts of cutting current expenditure are not modeled.
  - Future research could investigate revenue mobilization and different financing sources.

### Appendix and tables — selected exact figures and notes
- Table A1 and A2: Lists of small states and 2015 exchange rate classifications for IMF and WB definitions (IMF definition sample reduced to 23; WB sample 34 with some differing entries marked *).
- Table A3 (23 Small States, IMF definition):
  - Observations (impact regression period): N 231; example R-sq 0.289; adj. R-sq 0.214.
  - Standard errors clustered at country level. Significance markers: * 0.125, ** 0.1, *** 0.05 significance level.
  - Note: Natural Disaster, Net Exports, Tax, Government Revenue are all in % of GDP and controlled contemporaneously at each horizon (in t+h).
- Table A4 (34 Small States, WB definition):
  - Observations (impact regression period): N 340; example R-sq 0.209; adj. R-sq 0.155.
- Table A5: Comparisons of fiscal multipliers for small states (selected exact entries preserved in the source).
- Exclusions and notes:
  - Table A1 note: excluded IMF-defined small states meeting exclusion criteria include Djibouti (DJI), Kiribati (KIR), Maldives (MDV), Nauru (NRU), Palau (PLW), St Lucia (LCA), Samoa (WSM), Sao Tome and Principe (STP), Timor-Leste (TLS), Tuvalu (TUV), and Vanuatu (VUT).
  - Table A2 note: excluded WB-defined small states meeting exclusion criteria list preserved exactly in source.

*Italic: Source — content extracted from wpiea2019072 - REFERENCES:  __________________________________________________________32*

### REFERENCES:  __________________________________________________________32

### wpiea2019072 - REFERENCES:  __________________________________________________________32

### Key facts and motivation
- Average government debt of small states rose from about 50 percent of GDP before the global financial crisis to about 60 percent of GDP in 2019.
- Both domestic and external government debt rose during this period, with external debt contributing more to the rise in overall debt.
- Government expenditures sharply increased after the 2007-09 global financial crisis; government spending growth has continued in recent years in response to exogenous shocks including commodity prices, natural disasters, and exchange rate depreciations.
- The increase in government spending has been mostly in current spending, while capital spending has remained modest.
- Many small states face: small populations, narrow production bases, limited diversification, limited economic scales, geographic remoteness, and proneness to climate change and natural disasters—factors that may lower fiscal multipliers (e.g., via higher import shares of GDP and higher risk premia).

### Research objective and contribution
- Objective: Estimate fiscal policy multipliers—the impact of fiscal policy on GDP—for small states.
- Contribution:
  - Uses two distinct models: an empirical forecast-error/local-projection approach and a DSGE-type (GIMF) model calibrated to a hypothetical small open economy.
  - Empirical sample: larger than prior studies (main sample: 23 small states; robustness: 34 small states per World Bank definition).
  - Empirical innovations: local projection method (Jorda, 2005), forecast error approach using WEO vintages to mitigate foresight, and augmentation to include future fiscal shocks (per Teulings and Zubanov, 2014).

### Empirical approach and identification
- Baseline local projection specification (equation (1)) estimates GDP growth impacts of unanticipated fiscal shocks over horizons h using:
  - Country fixed effects (α_j), time fixed effects (γ_t), fiscal shock terms for government investment (I) and government current primary spending (C), control set X (including two lags of GDP growth, fiscal variables in levels as percent of GDP, cumulative future fiscal shocks between t+1 and t+h, and a natural disaster damage variable as percent of GDP).
- Forecast-error identification:
  - Fiscal shock FShock_j,t^k = actual (from October WEO of following year) minus forecast (from October WEO of that year), with fiscal variables scaled by previous year’s GDP.
  - Using October WEO vintages mitigates anticipation effects and reduces contemporaneous endogeneity within final quarter (October–December) of the year.
  - Robustness check: controlling for tax revenues; results are robust.

### Data
- Annual data for 1990-2017 from IMF WEO vintages.
- Main small-state sample: IMF definition (34 countries); empirical sample restricted to 23 countries after excluding cases for insufficient or unreliable data and extreme variance.
  - Final 23 countries composition: 5 from Africa, 6 from Asia, 11 from the Caribbean, and 1 from Europe.
- Series definitions used:
  - Real GDP growth: October 2018 WEO, series ngdp_r.
  - Government investment: series gcek prior to 2010 and ggaan_t after 2010.
  - Government current primary spending: gcec prior to 2000 and total general government expense gge after subtracting interest payment ggei thereafter.
- Natural disaster damage data: EM-DAT.

### Empirical results (baseline)
- Medium-term multipliers:
  - Government current primary spending multipliers: around zero (medium term).
  - Government investment multipliers: closer to 1 (medium term).
  - Medium-term tax multipliers: estimated at a fraction of the medium-term government investment multipliers.
- Short-run (impact) multipliers:
  - Empirical model: government current primary spending impact multiplier ≈ 0.4.
  - GIMF model: government current primary spending impact multiplier ≈ 0.6.
- Detailed baseline empirical patterns:
  - A +1 percent of GDP increase in government current primary spending:
    - Increases output by about 0.3 percent on impact (year 1).
    - Peaks in year 2 at around 0.4 percent.
    - Declines over time to zero (no prolonged medium-term effect).
  - Government investment:
    - Small effect on GDP at impact.
    - Relatively large and positive medium-term effect (example: about 0.2 percent of GDP in year 2 as reported in the text).

### Model-based (GIMF) analysis and sensitivity
- Uses the IMF’s Global Integrated Monetary and Fiscal (GIMF) model calibrated to a hypothetical small open economy.
- GIMF sensitivity analysis indicates multipliers vary with:
  - Imports as share of GDP.
  - Level of government debt.
  - Position in the business cycle.
- GIMF results broadly consistent with empirical findings: smaller medium-term multipliers for current primary spending and larger multipliers for government investment; impact multipliers for current primary spending higher than medium-term.

### Policy implications (from findings)
- For small states with large debt levels, fiscal consolidation is necessary to place public finances on a sustainable path and build fiscal space for future shocks; however, policymakers should weigh potential GDP costs:
  - Current primary spending has small and mostly short-lived effects on GDP—consolidation via reductions in current primary spending may have limited persistent output costs relative to cuts in investment.
  - Government investment shows larger medium-term multipliers—protecting or prioritizing public investment can yield larger medium-term GDP benefits.
- Design of fiscal consolidation or stimulus should consider country-specific features that affect multipliers (import openness, debt level, business-cycle position, and prevalence of natural disasters).

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### 0.9 percent in the fourth year. In

### wpiea2019072 - 0.9 percent in the fourth year. In

### Expansion vs Consolidation
- Specification extended to separate fiscal shocks into positive (expansionary) and negative (consolidation) episodes via equation (3).
- Positive shocks: 퐹퐹퐹퐹ℎ표표표표표표푗푗,푡푡푘푘,퐸퐸퐸퐸퐸퐸 contains only positive (expansionary) fiscal shocks; negative shocks: 퐹퐹퐹퐹ℎ표표표표표표푗푗,푡푡푘푘,퐶퐶퐹퐹퐶퐶퐹퐹 contains only negative (consolidation) fiscal shocks and set to be zero otherwise.
- Empirical findings:
  - Government current primary spending multiplier for expansion episodes is smaller than for consolidation episodes (Columns 2 and 3 in Table 1).
  - When government increases current primary spending, it does not boost GDP by much at impact nor in the medium term.
  - When government reduces government current primary spending:
    - negative impact of around 0.4 percent on GDP at impact;
    - negative impact of 0.8 percent at the peak after one year.

### Recession vs Boom Multipliers
- Modify equation (1) using a smooth transition function G(zi,t) = exp(−γzi,t) / (1+exp(−γzi,t)), γ>0, where zi,t is GDP growth rate normalized to zero mean and unit variance; γ set to 1.5 (robust to alternative γ).
- Empirical findings (Columns 4 and 5 in Table 1):
  - Government current primary spending multiplier:
    - 0.6 on impact during recessions;
    - does not have any notable effect on GDP during booms.
  - Government investment multiplier:
    - around 0.8 on impact during recessions;
    - negative fiscal multiplier during booms.

### Robustness Checks
- Battery of robustness checks summarized in Table A3:
  - Estimating equation (2) using only country fixed and time fixed effects (Column 4).
  - Adding lagged variables (Column 5).
  - Controlling for natural disasters (Column 6).
  - Controlling for future fiscal shocks (Column 7).
  - Controlling for terms of trade (Column 8), net exports (Column 9), government tax (Column 10), government revenue (Column 11).
  - Separate regressions for government current primary spending (Column 12) and government investment (Column 13).
- Additional robustness:
  - Changing sample definition from IMF’s small states to WB’s small states increases sample from 23 to 34 countries; qualitative results hold.
  - Results robust to changes in control variables (lag of difference in fiscal variable as in Auerbach and Gorodnichenko (2013), lags of fiscal shocks, combinations of lagged fiscal variables).
  - Results robust to threshold values for classifying outliers, using trend GDP instead of actual GDP to divide variables, and using previous year’s WEO data instead of current year’s to obtain fiscal variable forecast.
- World Bank sample (34 countries): impact multiplier was 0.2 and 0 for government current primary spending compared to baseline multipliers of 0.3; government investment five-year multiplier 0.6 for larger sample compared to baseline 0.9.
- Estimations for initially highly-indebted countries (government debt > 70 percent of GDP) yield coefficients similar to baseline specification.

### Summary of Empirical Results
- Main empirical results summarized in Figure 8:
  - Government current primary spending:
    - short-term impact multiplier of around 0.3;
    - negligible medium-term impact on growth.
  - Government investment:
    - small impact multiplier;
    - relatively large medium-term multiplier of around 0.9 on output (by fourth year as noted earlier).

### GIMF Model and Calibration
- DSGE model: IMF’s Global Integrated Monetary and Fiscal (GIMF) model — open-economy DSGE where Ricardian equivalence does not hold.
- Key model features:
  - Overlapping-generation agents with finite lifetimes; some liquidity constrained.
  - Multiple real and nominal rigidities: consumer habits, investment adjustment costs, import adjustment costs.
  - Productive public infrastructure spending that adds to public capital stock and enhances productivity.
- 3-economy calibration: hypothetical small state, the United States, and aggregate rest of world.
- Hypothetical small state calibration values and assumptions (steady state; each period = one year):
  - Population share of small state: 0.001 percent of world GDP (interpretation: comprises 0.001 percent of world GDP).
  - Real GDP growth rate (percent; annual): 1.5
  - Inflation rate (percent; annual): 7.0
  - Real gross interest rate (percent; annual): 4.0
  - Population growth rate (percent; annual): 1.0
  - Share of liquidity-constrained agents (percent): 50.0
  - Fiscal ratios (percent of GDP):
    - Government Consumption to GDP: 20.0
    - Public investment to GDP: 4.7
    - Tax revenue to GDP: 22.5
      - Consumption taxes: 7.5
      - Capital taxes: 4.0
      - Labor taxes: 8.0
      - Lump sum taxes: 3.0
    - Government Debt: 61.0
  - Imports (percent of GDP): 61.0
  - Labor Shares (percent): 55.0
  - Labor Share; nontradables (percent): 60.0
  - Investment Share (percent): 17.2
  - Population Share in the World; small state (percent)*: 0.0
  - Population Share in the World; U.S. (percent): 23.0
  - Population Share in the World; rest of the world (percent): 77.0
- Additional calibrations:
  - Small state initial level for both imports and government debt set at 61 percent of GDP (2017 average for sample).
  - Households planning horizon: 15 years (probability of death 6.7 percent per year).
  - Decline in lifecycle worker productivity: 5 percent per year.
  - Half of small state’s households are liquidity-constrained (50.0 percent).

### GIMF Model Results — Baseline Multipliers
- Baseline scenario: permanent public-debt-reducing shocks that reduce overall fiscal deficit permanently by 1 percent of GDP; assume no monetary policy reaction.
- Five-year baseline fiscal multipliers (effects on level of GDP after five years; Figure 10):
  - Government current primary spending multiplier: almost zero (i.e., after five years, cumulative GDP effect of a consolidation through reducing government current primary spending is almost zero).
  - Government investment multiplier (five-year): around 0.6.
    - Interpretation: permanently reducing investment by 1 percent of GDP implies economy would lose a cumulative 0.6 percent of GDP over five years.
- Five-year multipliers of consolidation through increasing taxes (Figure 10):
  - Consumption taxes: about 0
  - Labor taxes: 0.4
  - Capital taxes: 0.6
- Time profile (Table 3):
  - Multipliers are relatively larger at impact and decrease thereafter in many cases.
  - Where consolidation affects capital stock (government investment and taxes on capital), multipliers increase again over the medium term until reaching steady state levels.
  - In other cases, multipliers continue falling through medium term and beyond until they reach zero.

### Dynamics of Consolidation via Lower Government Consumption (GIMF)
- Shock calibrated to permanently lower overall fiscal deficit by 1 percent of GDP via reduced government consumption.
- Fiscal variable dynamics (Figure 11a):
  - Government consumption lowered; government investment and transfers remain virtually unchanged compared with baseline.
  - Government debt falls on a declining trend compared to baseline.
  - Government interest expenditures decrease over time as debt falls.
  - Declining interest expenditures imply improving primary fiscal balance over time.
- Macroeconomic dynamics (Figure 11b):
  - Impact multiplier of a government consumption consolidation shock: about 0.6 at impact.
  - Multiplier shrinks over time, reaching around 0 after about four years.
  - At impact, private consumption and investment decline as public jobs and government contracts are lost.
  - Over time, private consumption and investment gradually return to fundamental levels, helped by improving primary balance.
  - Consolidation leads to lower inflation; with nominal exchange rate broadly unchanged, results in real exchange rate depreciation.
  - Real exchange rate depreciation boosts exports and lowers imports; imports dampen more at impact due to simultaneous declines in government and private domestic demand; imports partially recover as private demand improves.
- Table 4 (contributions to growth): first row shows total impact on GDP (fiscal multiplier) over six years when government cuts overall fiscal deficit through government consumption by 1 percent of GDP; private consumption and investment also decline in response.

_Italic: Source: Authors' estimates and model calibration as presented in the provided content._

### 1.3 percent. However, imports would also decline as a result of lower government and

### wpiea2019072 - 1.3 percent. However, imports would also decline as a result of lower government and

### Permanent consolidation using lower government investment: dynamics and quantitative impacts
- Shock calibration:
  - Shock permanently lowers the overall fiscal balance by 1 percent of GDP through government investment.
  - Government investment is lowered; government consumption and transfers remain virtually unchanged to the steady state.
  - "Long Run" refers to 20 years after the initial shock period.
- Key short- and medium-term effects:
  - Total impact on GDP at impact: -0.6 percent (contribution to the level of GDP).
  - Government spending contribution: ranges reported across periods include values such as -1.1, -1.0, -0.9, -0.8, -0.7, -0.6 (percent contributions displayed in figures).
  - Government consumption contributions shown include values such as -1.2, -1.1, -0.9, -0.8, -0.7, -0.6 (percent contributions displayed in figures).
  - Net exports contribution increases (positive): examples shown 0.9, 1.0, 1.0, 0.9, 0.7, 0.6 (percent contributions displayed in figures).
  - Exports contribution examples: 0.1, 0.2, 0.3, 0.3, 0.2 (percent contributions displayed).
  - Imports contribution examples: -0.8, -0.8, -0.7, -0.6, -0.5, -0.4 (percent contributions).
  - Private consumption and private investment decline at impact (examples in figures: private consumption around -0.2 to -0.1; private investment around -0.1).
- Mechanisms and persistence:
  - Immediate negative effect on private consumption and investment as consumers lose public jobs and businesses lose government contracts.
  - Over time, private consumption and investment recover but settle at lower steady-state levels because lower government investment permanently depresses the capital stock and production.
  - Consolidation lowers inflation and depreciates the real exchange rate, improving the trade balance via higher exports and lower imports; as private demand recovers imports partly increase.
  - Decline in government investment produces a more lasting output reduction than a comparable decline in government consumption; in the very long term (well beyond 20 years) output effect returns to zero as private investment eventually replaces lost public investment.
- Fiscal variables behavior:
  - Government debt declines over time due to the permanently lowered fiscal deficit.
  - Primary fiscal balance improves over time concomitant with lower government debt.
  - Interest expenditures and other fiscal components adjust as shown in model charts (percent deviations from steady state).

### Primary, temporary, and disaster-related multipliers
- Primary multipliers:
  - Primary multipliers are larger than baseline multipliers.
  - Rationale: baseline multipliers assume lower overall balance leading to falling interest expenditures and improving primary balance over time; primary multipliers hold the primary balance unchanged so they are larger.
- Temporary multipliers:
  - Temporary shock experiment: reduce overall deficit in the first year by 1 percent of GDP and return to steady state in the following year; all future years unchanged.
  - Temporary multipliers are notably smaller than baseline (permanent) multipliers.
  - Some temporary multipliers may show "wrong" signs due to small sizes and model dynamics.
- Multipliers following natural disasters:
  - Natural disaster assumed to destroy 10 percent of the country’s GDP in the initial period; fiscal policy is implemented thereafter.
  - Five-year cumulative GDP impacts:
    - Government consumption post-disaster: medium-term multiplier close to 0.4 (notably larger than baseline).
    - Government investment post-disaster: medium-term multiplier estimated at 0.7 (slightly larger than baseline).
  - Interpretation: larger multipliers when there is slack in the economy; results align with empirical findings of larger multipliers in recessions compared to booms.

### Sensitivity analysis (country characteristics)
- Experiment setup:
  - Baseline calibrated for a hypothetical small state with average imports and government debt of all small states.
  - Sensitivity examined for three characteristics: (i) imports share, (ii) government debt level, (iii) share of liquidity-constrained households.
- Imports share:
  - Range analyzed: 30 to 80 percent of GDP.
  - Finding: The higher the imports share, the lower the fiscal multipliers (greater trade leakage). This holds for impact (one-year) and medium term (five-year).
- Government debt level:
  - Range analyzed: 20 to 120 percent of GDP.
  - Finding: The higher the government debt level, the higher the fiscal multipliers. Rationale: consolidation lowers the risk premium more for higher-debt countries, yielding larger benefits.
- Share of liquidity-constrained households:
  - Range analyzed: 20 to 60 percent of population.
  - Finding: The larger the share of liquidity-constrained households, the larger the fiscal multipliers, because hand-to-mouth behavior raises the marginal propensity to consume.

### Comparisons with previous studies and broader literature
- Empirical and model results summarized:
  - Empirical results in this study: government consumption impact multiplier around 0.3-0.4 with negligible medium-term impact on GDP.
  - GIMF model: government consumption impact multiplier around 0.6 with negligible medium-term impact on GDP.
  - Both empirical and GIMF results: government investment has larger medium-term growth impact than government consumption, with fiscal multipliers around 0.6-1.1.
  - Impact multipliers in short term: government consumption and investment around ½ (as stated).
  - Tax multipliers: larger than government consumption multipliers but smaller than government investment multipliers.
  - Expansionary policy multipliers are generally smaller than consolidation multipliers due to increased risk premia for small states with high government debt.
- Literature context:
  - SVAR and narrative studies for small states report small to moderate multipliers (examples: government consumption ~0.1-0.2 impact in some SVAR studies; government investment up to ~0.4 after one year in some estimates).
  - DSGE study cited (Dodzin and Bai, 2016) finds an impact government consumption multiplier around 0.5 for Palau and Kiribati.
  - For broader LAC sample, studies find multipliers between 0.5 and 1.1 with government consumption impact ~0.2 and government investment impact ~0.6 on impact and 1.1 after a year.
  - Literature review (Batini et al., 2014) reports fiscal multipliers for low-income and emerging economies generally low at around 0.2 to 1.3 with many panel studies around 0.2-0.5 on impact.
- Methodological note:
  - Authors justify using a forecast error approach with local projections over SVAR or narrative approaches for small states due to data frequency, anticipation effects, and allowance for nonlinear responses.

### Concluding remarks and policy implications
- Main conclusions:
  - Government consumption has a medium-term fiscal multiplier of about zero on the level of GDP; government investment has a multiplier around 0.6-1.1.
  - Short-term (impact) multipliers for government consumption and investment are around ½.
  - Government investment affects potential GDP in small states more than government consumption.
- Policy recommendations:
  - Small-state governments needing consolidation are advised to design consolidation in favor of cutting government consumption and avoid cutting government investment where feasible.
  - A consolidation plan that includes expansion of government investment within the overall consolidation envelope can be growth friendly.
- Caveats and areas for future work:
  - Results may depend on how government spending is financed; GIMF model assumes fiscal policy financed by surplus/deficit, while the empirical part does not consider financing sources.
  - Higher public investment financed by debt may not be desirable if returns on public investment do not offset interest on domestic and external loans.
  - Political difficulty and distributional impacts of cutting current expenditure are not modeled.
  - Future research could investigate revenue mobilization and different financing sources.

*Source: Authors' estimates and analysis as presented in the supplied content.*

### REFERENCES:

### REFERENCES

### Key References
- Auerbach, A. J., and Y. Gorodnichenko, 2013, "Output Spillovers from Fiscal Policy.” American Economic Review Papers and Proceedings 103(2013), 141-146.
- Batini, N, L. Eyraud, L. Forni., and A. Weber, 2014, “Fiscal Multipliers, Size, Determinants, and Use in Macroeconomic Projections. IMF Technical Guidance Note, International Monetary Fund, Washington, DC.
- Blanchard, O., and R. Perotti, 2002, “An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output.” Quarterly Journal of Economics 126: 51–102.
- David, A., and D. Leigh, 2018. “A New Action-Based Dataset of Fiscal Consolidation in Latin America and the Caribbean.” IMF Working Paper 18/94, International Monetary Fund, Washington, DC.
- Dodzin S., and X. Bai, 2016, “Estimating Fiscal Multipliers Using a Simplified General Equilibrium Model of Small States, with Application to Kiribati and Palau.” In the edited book “Resilience and Growth in Small States of the Pacific” by Khor, H.E.
- Kronenberg, R. P., and Tumbarello, P.
- Furceri, D., and B. G. Li, 2017, “The Macroeconomic (and Distributional) Effects of Public Investment in Developing Countries” IMF Working Paper 17/217, International Monetary Fund, Washington DC.
- Furceri, D., J. Ge., P. Loungani., and G. Melina, 2018, “The Distributional Effects of Government Spending Shocks in Developing Economies.” IMF Working Paper 18/57, International Monetary Fund, Washington DC.
- Forni, M., and L. Gambetti, 2016, “Government Spending Shocks in Open Economy VARs” Journal of International Economics, Vol 99: 68-84.
- Gonzalez-Garcia J., A. Lemus, and M. Mrkaic, 2013, “Fiscal Multipliers in the ECCU”. IMF Working Paper 13/17, International Monetary Fund, Washington DC.
- Guy, K. and A. Belgrave, 2012, “Fiscal Multiplier in Microstates: Evidence from the Caribbean.” International Advances in Economic Research, Vo 18: 1, 74–86.
- IMF, 2015 “Annual Report on Exchange Arrangements and Exchange Restrictions” (AREAER). https://www.elibrary-areaer.imf.org/Pages/Home.aspx
- IMF, 2017, “2017 Staff Guidance Note on the Fund’s Engagement with Small Developing States”. https://www.imf.org/en/Publications/Policy-Papers/Issues/2018/01/26/pp121117-2017-staff-guidance-note-on-the-funds-engagement-with-small-developing-states
- IMF, 2018, Chapter 4 “Fiscal Multipliers: How Will Consolidation Affect Latin America and Caribbean?” Regional Economic Outlook: Western Hemisphere Region April 2018.
- Ilzetzki, E., E. G. Mendoza, C. A. Végh, 2013, “How big (small?) are fiscal multipliers?” Journal of Monetary Economics, 60 (2): 239-254.
- Jorda, O., 2005, “Estimation and Inference of Impulse-Response by Local Projections.” American Economic Review 95(1): 161-82.
- Kumhof, M., and D. Laxton, 2007. "A Party without a Hangover? On the Effects of U.S. Government Deficits," IMF Working Papers 07/202, International Monetary Fund.
- Narita, M., 2014, “Fiscal Multipliers in the Caribbean.” in Caribbean Renewal: Tackling Fiscal and Debt Challenge edited by Amo-Yartey, C and Turner-Jones, T.
- Owyang, M. T., V. A. Ramey., and S. Zubairy, 2013, “Are Government Spending Multipliers Greater during Times of Slack? Evidence from 20th Century Historical Data.” American Economic Review Paper and Proceedings. 103:2, 129–34.
- Ramey, V A, and S. Zubairy, 2018, “Government Spending Multipliers in Good Times and in Bad: Evidence from US Historical Data.” Journal of Political Economy 126:2, 850-901.
- Romer C., and D. Romer, 2010, “The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks.” American Economic Review 100: 763–801.
- Teulings, C. N, and N. Zubanov, 2014, “Is Economic Recovery a Myth? Robust Estimation of Impulse Responses.” Journal of Applied Econometrics 29: 497–514.
- World Bank, 2018, Small States: Overview. http://www.worldbank.org/en/country/smallstates/overview
- World Bank, 2016, “World Bank Group Engagement with Small States: Taking Stock”. http://pubdocs.worldbank.org/en/244361475521083722/Small-States-Stocktaking-2016.pdf

### Exclusions and Notes from Reference Appendix
- Table A1 note: "The list includes all small states based on the IMF definition from IMF (2017) except for those that meet the exclusion criteria as explained in the main text, which are Djibouti (DJI), Kiribati (KIR), Maldives (MDV), Nauru (NRU), Palau (PLW), St Lucia (LCA), Samoa (WSM), Sao Tome and Principe (STP), Timor-Leste (TLS), Tuvalu (TUV), and Vanuatu (VUT)."
- Table A2 note: "Countries with * are small states based on WB’s definition in the sample that are not small states based on IMF’s definition. The list includes all small states based on the WB definition from IMF (2017) except for those that meet the exclusion criterion, which are Bahrain, Djibouti, Guinea-Bissau, Equatorial Guinea, Kiribati, St. Lucia, Maldives, Nauru, Palau, Qatar, San Marino, Sao Tome and Principe, Timor-Leste, Tuvalu, and Vanuatu."

### Appendix: Tables — Key Data and Findings
- Table A1: List of Small States and 2015 Exchange Rate Classifications (IMF definition)
  - Entries numbered 1 to 23 with ISO Codes and Exchange Rate Classification. Examples (exact text preserved): "1 CPV Cabo Verde Africa Conventional peg", "2 COM Comoros Africa Conventional peg", ... , "23 MNE Montenegro Europe No separate legal tender".
  - Sources: IMF (2017) and IMF (2015).

- Table A2: List of Small States and 2015 Exchange Rate Classifications (WB definition)
  - Entries numbered 1 to 34 with Country Name, Region, Exchange Rate Classification. Examples (exact text preserved): "1 Botswana* Africa Crawling peg", "2 Cabo Verde Africa Conventional peg", ... , "34 Cyprus* Europe Free floating".
  - Note: "Countries with * are small states based on WB’s definition in the sample that are not small states based on IMF’s definition."

- Table A3: Empirical Results (23 Small States, IMF definition) (Fiscal Multipliers)
  - Key model features: Country & Time Fixed Effects: Yes; Lagged Variables: Yes; Natural Disaster Damage: Yes; Future Fiscal Shocks: Yes; Terms of Trade: Yes; Net Exports: Yes; Tax Revenue: Yes; Government Revenue: Yes.
  - Observation and fit statistics (impact regression period): N 231; R-sq 0.289 (in one column example); adj. R-sq 0.214 (in one column example).
  - Standard errors clustered at country level. Significance markers: * 0.125, ** 0.1, *** 0.05 significance level.
  - Note: "Natural Disaster, Net Exports, Tax, Government Revenue are all in % of GDP and those variables and Terms of Trade variable are all controlled contemparaneously at each horizon (in t+h)."

- Table A4: Empirical Results (34 Small States, WB Definition) (Fiscal Multipliers)
  - Key model features: Country & Time Fixed Effects: Yes; Lagged Variables: Yes; Natural Disaster Damage: Yes; Future Fiscal Shocks: Yes; Terms of Trade: Yes; Net Exports: Yes; Tax Revenue: Yes; Government Revenue: Yes.
  - Observation and fit statistics (impact regression period): N 340 (in one column example); R-sq 0.209 (in one column example); adj. R-sq 0.155 (in one column example).
  - Standard errors clustered at country level. Significance markers: * 0.125, ** 0.1, *** 0.05 significance level.
  - Note: "Natural Disaster, Net Exports, Tax, Government Revenue are all in % of GDP and those variables and Terms of Trade variable are all controlled contemparaneously at each horizon (in t+h)."

- Table A5: Comparisons of Fiscal Multipliers for Small States (Fiscal Multipliers) — Selected exact entries
  - This Paper (Empirical: LPM Forecast Errors): 
    - Government Consumption On Impact: 0.27-0.39*
    - Government Consumption Medium Term: -0.12
    - Government Investment On Impact: 0.10-0.26*
    - Government Investment Medium Term: 0.88-1.06*
    - Tax On Impact: n.a
    - Tax Medium Term: n.a
    - Sample: 23 Small States (IMF)
    - Methodology: Local Projection Method with Forecast Errors, WEO 1990-2017 Annual data
  - This Paper (34 Small States, World Bank): 
    - Government Consumption On Impact: 0.16*
    - Government Consumption Medium Term: -0.11
    - Government Investment On Impact: 0.1-0.20*
    - Government Investment Medium Term: 0.61-0.84*
    - Tax On Impact: n.a
    - Tax Medium Term: n.a
    - Sample: 34 Small States (World Bank)
  - DSGE: GIMF (hypothetical small state):
    - Government Consumption On Impact: 0.58*
    - Government Consumption Medium Term: 0.05*
    - Government Investment On Impact: 0.68*
    - Government Investment Medium Term: 0.57*
    - Tax On Impact: -0.36*
    - Tax Medium Term: -0.01
  - Literature examples (exact entries preserved):
    - Gonzales-Garcia and others (2013): Government Consumption On Impact: 0.20; Government Consumption Medium Term: 0.00; Government Investment On Impact: 0.12*; Government Investment Medium Term: 0.44*; Tax On Impact: -0.5*; Tax Medium Term: 0
    - Narita (2014): Government Consumption On Impact: 0.13*; Tax Medium Term: -0.51*
    - Guy and Belgrave (2012)**: Government Consumption On Impact: 0.11-0.18*; note "wrong sign" entry preserved.
    - Dodzin and Bai (2016): Government Consumption On Impact: 0.16*, 0.47*
    - WHD 2018 April REO: Government Consumption On Impact: 0.21*; Government Investment On Impact: 0.60*; Tax On Impact: -0.5*
  - Methodological note from Table A5: "Values with asterisk * are statistically different from zero, on impact multiplier is the impact in year of the shock, medium terms impact shows 4-5-year cumulative impact. For Guy and Belgrave (2012), impact multipliers imply multiplier after 4 quarters."
  - Definition note from Table A5: "Ɨ Government consumption in our empirical section refers to current primary spending, which is government expense minus interest payments and includes transfers."

*Source: wpiea2019072 - REFERENCES (IMF PDF).*

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_Source: https://www.imf.org/-/media/files/publications/wp/2019/wpiea2019072.pdf_