## _wp1493 — 1. Narrative Approach: First-Year Tax Multipliers

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### Definitions and purpose
- Fiscal multipliers measure the short-term impact of discretionary fiscal policy on output; defined as the ratio of a change in output (∆Y) to a discretionary change in government spending or tax revenue (∆G or ∆T).
- Impact multiplier = (∆Y(t))/(∆G(t)). Multiplier at horizon i = (∆Y(t+i))/(∆G(t)).
- “Overall” multiplier: output response to an unspecified fiscal shock. “Revenue” (“spending”) multiplier: output response to a discretionary change in revenue (spending).
- This paper refers to multipliers as one-year multipliers unless otherwise stated.
- Better estimation and use of multipliers can improve macroeconomic forecast accuracy and fiscal policy design. Under-estimation of multipliers early in the crisis contributed significantly to growth forecast errors (Blanchard and Leigh, 2013).
- Estimation challenges: two-way relationships between fiscal variables and output (automatic stabilizers and discretionary responses), identification of exogenous fiscal shocks, and data limitations for econometric and model-based methods (SVAR, DSGE).
- Where no reliable estimate is available, the paper proposes a “bucket approach” to group countries with similar expected multiplier values based on characteristics.

### Narrative approach: methodological advantage
- Narrative approach identifies exogenous fiscal shocks directly rather than filtering automatic stabilizers via output elasticities.
- On taxes: narrative studies extract fiscal measures from budget documents and exclude measures taken in response to short-term macroeconomic fluctuations.
- On spending: some narrative studies use news about future military spending as exogenous spending shocks (military spending assumed determined by wars/foreign policy, not the state of the economy).

### Main empirical findings from narrative studies — First-year tax multipliers
- Reported estimates correspond to the response of output in percent following an exogenous tax shock of 1 percent of GDP. First year multiplier unless otherwise noted.
- Selected first-year tax multipliers and peak timing:
  - Cloyne (2013), United Kingdom: 0.6 — Maximum multiplier reached after 10 quarters (about 2.5).
  - Favero and Giavazzi (2012), United States: 0.7 — Maximum multiplier reached after 9 quarters (just below 1).
  - Guajardo and others (2014), Panel of OECD Countries: 1 — After two years, multiplier reaches about 3.
  - Hayo and Uhl (2014), Germany: 1 — Maximum multiplier after 8 quarters (about 2.4).
  - Mertens and Ravn (2013), United States: 1 — Maximum multiplier reached after 8 quarters (about 2).
  - Romer and Romer (2010), United States: 1.2 — Maximum multiplier reached after 10 quarters (around 3).

### Narrative studies on spending multipliers — First-year and near-term estimates
- Reported estimates correspond to the response of output in percent following an exogenous spending shock of 1 percent of GDP. First year multiplier unless otherwise noted.
- Selected first-year and near-term spending multipliers:
  - Barro and Redlick (2011): 0.4–0.6 — Based on U.S. defense spending news; 1917–2006; lower multiplier for temporary spending changes, higher end for permanent changes.
  - Guajardo and others (2014): 0.3 — Overall spending shock. After two years, multiplier reaches about 1.
  - Hall (2009): 0.6 — Based on U.S. defense spending news; 1930–2008.
  - Owyang, Ramey, Zubairy (2013): United States: 0.8; Canada: 0.4–1.6 — Two year multipliers; Canada range reflects low unemployment (low multiplier) and high unemployment (high multiplier) regimes.
  - Ramey (2011): 1.1–1.2 — Based on U.S. defense spending news; 1939–2008. Peak multiplier after 6 quarters.

### Key pattern highlighted by narrative evidence
- Narrative studies challenge the conventional view that spending multipliers are always larger than revenue multipliers—some narrative tax multipliers are as large or larger than spending multipliers in first-year and peak responses.

### Multipliers in EMEs and LICs (summary)
- Theoretical ambiguity: unclear whether multipliers in EMEs and LICs should be higher or lower than in AEs; Table 3 lists opposing factors.
- Factors increasing multipliers in EMEs and LICs:
  - Less consumption smoothing with liquidity constraints and weaker forward-looking behavior.
  - Larger room for credibility and confidence effects with higher interest spreads.
  - Smaller economies and less openness (in some cases) reduce demand leakage.
- Factors decreasing multipliers in EMEs and LICs:
  - Precautionary saving in more uncertain environments.
  - Inefficiencies in public expenditure management and revenue administration.
  - Lower automatic stabilizers.
  - Greater openness and small size causing demand leakage through imports.
  - Lower government debt in some countries reducing scope for demand effects.
- Empirical evidence (limited) suggests multipliers in EMEs and LICs are smaller than in AEs (Estevão and Samake, 2013; Ilzetzki and others, 2013; Ilzetzki, 2011; IMF, 2008; Kraay, 2012). Some studies find negative multipliers in the longer term or when public debt is high.
- Instrument-specific short-term estimates in EMEs:
  - Ilzetzki (2011): spending multipliers range from 0.1 to 0.3 and revenue multipliers lie between 0.2 and 0.4 in the short term.
  - Ilzetzki and others (2013): combination of government consumption multiplier of zero and government investment multiplier of 0.6 explains a low overall spending multiplier.

### Determinants of multiplier size
- Two classes of determinants:
  - Structural country characteristics that influence response in “normal times.”
  - Conjunctural/temporary factors (cyclical or policy-related) that make multipliers deviate from normal levels.
- Structural characteristics identified:
  - Trade openness: Lower propensity to import → higher fiscal multipliers.
  - Labor market rigidity: More rigid labor markets → larger multipliers.
  - Size of automatic stabilizers: Larger automatic stabilizers → lower multipliers.
  - Exchange rate regime: Flexible exchange rates → smaller multipliers.
  - Debt level: High-debt countries → generally lower multipliers.
  - Public expenditure management and revenue administration: Inefficiencies → smaller multipliers.
- Conjunctural factors:
  - State of the business cycle: Multipliers generally larger in downturns than in expansions. Evidence suggests downturns increase multipliers more than expansions decrease them.
  - Degree of monetary accommodation: Expansionary monetary policy lowers contractionary impact of fiscal consolidation; multipliers can be much larger when monetary policy is impaired (e.g., at the zero lower bound, ZLB). Effects at the ZLB are conditional on shock size and implementation lags.

### Empirical evidence over the business cycle (selected results)
- Selected entries (spending and revenue multipliers, various horizons and states):
  - Auerbach and Gorodnichenko (2012a), United States, 6 quarters: Expansion = 0; Linear = 0.4; Recession = 1.7 (spending).
  - Auerbach and Gorodnichenko (2012b), OECD, first year: Expansion = −0.2; Linear = 0.2; Recession = 0.5 (spending).
  - Auerbach and Gorodnichenko (2014), Japan, 4 quarters: Expansion = 1; Linear = 1.2; Recession = 2.4 (spending).
  - Batini and others (2012), 4 quarters: Expansion = 0.82; Linear = 0.93; Recession = 2.08 (spending); Expansion = −0.08; Linear = −0.17; Recession = 0.08 (revenue).
  - Baum and others (2012), 4 quarters: Expansion = 0.72; Linear = 0.79; Recession = 1.22 (spending); Expansion = −0.04; Linear = 0.29; Recession = 0.35 (revenue).
  - Canzoneri and others (2012), DSGE, United States, impact multiplier: Expansion = 0.89; Linear = 1.3; Recession = 2.25 (spending).
  - Hernandez de Cos and Moral-Benito (2013), Spain, 4 quarters: Expansion = 0.6; Linear = 0.65; Recession = 1.3 (spending).

### Zero Lower Bound (ZLB) and government spending multipliers
- Most literature focusing on temporary increases in government purchases finds the multiplier at the ZLB exceeds the “normal times” multiplier by a large margin (conditional on factors such as shock size and implementation timing).
- Selected model-based ZLB impact multipliers for temporary increases in spending (United States):
  - Christiano and others (2011): No ZLB 1.1; ZLB 3.7. Note: implementation lag of 1 period reduces the multiplier to 1.5.
  - Eggertson (2010): No ZLB 0.5; ZLB 2.3.
  - Erceg and Linde (2010): No ZLB 1; ZLB 4. ZLB multiplier of 4 based on a temporary spending increase of 1 percent of GDP and ZLB duration of 8 quarters. Larger positive spending shocks are associated with lower multipliers since they shorten ZLB duration; e.g., for a government spending increase above 3.5 percent of GDP, the multiplier declines to 1.5. A cut in spending can increase the multiplier; e.g., a cut of 1 percent of GDP is associated with a multiplier of up to 6.
- Results on tax measures at the ZLB are less conclusive; Eggertson (2010) finds labor and capital tax cuts at the ZLB can have contractionary effects (negative multipliers) in contrast to other findings on spending.

### Persistence of fiscal multipliers
- Output effects of an exogenous fiscal shock generally vanish within five years; effect usually has an inverted U shape with the maximum impact occurring in the second year.
- Mineshima and others (2014): the second-year multiplier is, on average, 10–30 percent higher than in the first-year.
- Determinants of persistence:
  - Persistence of the fiscal shock (temporary vs permanent): temporary measures tend not to have effects beyond the duration of the shock; permanent measures may be more persistent but generally do not last more than five years.
  - Type of fiscal instrument:
    - Permanent discretionary changes in indirect taxes, government consumption, and transfers typically have short-term output effects, vanishing within five years.
    - Permanent discretionary changes in public investment or corporate taxes can have longer-lasting or even permanent effects, with multipliers increasing after the first year toward long-term values.
  - Conjunctural factors:
    - Fiscal shocks in recessions or when production is below potential may have more persistent effects because of hysteresis or limited borrowing by credit-constrained agents.
    - Multipliers increase if the initial spending shock occurs in a recession and decline if it occurs in an expansion.
  - Monetary policy response:
    - Persistence is higher if monetary policy does not offset fiscal shocks.
    - A two-year public consumption stimulus can have a positive effect on output of up to five years if there is no monetary policy response; if monetary policy offsets the fiscal shock, effects do not last beyond the duration of the fiscal stimulus.

### The bucket approach — selecting first-year overall multipliers
- Purpose: For countries without readily available multipliers, group countries into three buckets (low, medium, high) based on structural characteristics likely to affect multipliers.
- Step 1 — Scoring (assign 1 point per characteristic present):
  - Low trade openness: ratio of imports to domestic demand below 30 percent on average over the past five years.
  - High labor market rigidities: labor market rigidity measures roughly 0.8–1 on indices ranging from 0-weak to 1-strong.
  - Small automatic stabilizers: ratio of public spending to nominal GDP below 0.40.
  - Fixed or quasi-fixed exchange rate regime: exchange rate arrangement not fully flexible (AREAER categories listed).
  - Low/safe public debt level: gross government debt below a level considered “safe” (AEs: 100 percent of GDP; EMEs: 40 percent of GDP).
  - Effective public expenditure management and revenue administration: assessed via PEFA and tax productivity measures.
- Step 2 — Bucket assignment (equal weights for characteristics):
  - Total scores 0 to 3: Low multipliers.
  - Total scores 3 or 4: Medium multipliers.
  - Total scores 4 to 6: Large multipliers.
  - Table 6 multiplier ranges (Normal Times):
    - Low multiplier 0.1–0.3
    - Medium multiplier 0.4–0.6
    - High multiplier 0.7–1.0
- Step 3 — Conjunctural adjustments (scale up/down range):
  - Cycle adjustment:
    - If economy at lowest point of cycle (maximum negative output gap based on historical patterns), increase both lower and upper bound by 60 percent.
    - If economy at peak (maximum positive output gap), decrease both bounds by 40 percent.
    - If output gap is zero, no adjustment. Interpolate for intermediate cases.
  - Monetary policy stance adjustment:
    - If monetary policy is at the effective lower bound and fully constrained, increase both bounds by 30 percent.
    - Interpolate between 0 and 30 percent if monetary policy is partially constrained.
- Multiplicative formula to combine effects:
  - M = M_NT * (1+Cycle) * (1+Mon)
    - Where M is final multiplier estimate, M_NT is the “normal times” multiplier derived from step 2, Cycle ranges from −0.4 to +0.6, and Mon ranges from 0 to 0.3.
- Resulting first-year multipliers under various combinations may vary from about 0 to 2.
- Notes on calibration:
  - Calibration based on AE studies but intended to be applied to EMEs and LICs with judgment.
  - No separate adjustment for fiscal package composition is introduced here.

### Illustration: United States example (bucket scoring and scaling)
- Scoring for the United States:
  - Relatively Closed 1
  - Rigid Labor Markets 0
  - Small Automatic Stabilizers 1
  - Fixed Exchange Rate Regime 0
  - Safe Government Debt 1
  - Effective expenditure/revenue management 1
  - Total score 4
- Bucket assignment and scaling (assuming negative output gap; U.S. public debt treated as “safe”):
  - Score 4 Medium (0.4–0.6) → Multiplier after scaling 0.6–0.9 (with +0.3 cycle and +0.1 constrained monetary policy)
  - Score 4 High (0.7–1) → Multiplier after scaling 1.0–1.4
- Comparison with literature:
  - Auerbach and Gorodnichenko (2012a) estimate a first-year expenditure multiplier of about 1.4 in recessions.
  - Baum and others (2012) find an overall downturn multiplier of 0.9 (assuming half adjustment falls on spending).
  - Batini and others (2012) find a multiplier of 1.2 with the same assumption.

### Caveats, extensions, and practical guidance
- The bucket approach is rule-of-thumb guidance and should not be applied mechanically; calibrated largely on AE studies.
- Use judgment and country-specific priors to adjust multipliers. Examples where further adjustments may be justified:
  - Large government-controlled economies with small private sectors: adjust multiplier upwards.
  - De jure flexible exchange rate regimes where monetary policy is constrained by currency mismatches: adjust upwards.
  - Highly credible fiscal adjustment: adjust multiplier downwards (confidence effects may reduce consolidation costs).
- Persistence for subsequent years:
  - Assume decline to zero in multiplier size over five years, with a potentially higher multiplier in the second year (10–30 percent relative to the first-year).

### Conclusions (summary)
- Fiscal multipliers are key inputs for assessing the short-term macroeconomic impact of fiscal policy and improve transparency and forecasting.
- Two main contributions of the paper:
  - Overview of literature on short-term multipliers and their determinants (structural and temporary factors), including findings for EMEs and LICs where multipliers tend to be lower.
  - Practical guidance (the bucket approach) to select multipliers where country-specific estimates are unavailable; the method identifies ranges and accounts for environmental factors but requires judgment and consideration of data and institutional specifics.
- Typical empirical finding: discretionary fiscal policy effects on output typically vanish within five years, with an inverted U profile and peak impact usually in the second year.

### Appendix I — Multiplier estimation techniques in the literature (key points)
- Two main methods: empirical estimation and model-based approaches (DSGE/New Keynesian).
- Empirical estimations:
  - VAR and SVAR widely used; variables typically include revenue, spending, output, interest rate and inflation.
  - SVARs extract structural shocks but may not capture purely exogenous fiscal shocks or state-contingent multipliers; narrative approaches improve identification.
  - Non-linear SVARs examine cycle-dependent multipliers.
- Model-based estimations (DSGE and New Keynesian):
  - DSGE models simulate fiscal impacts via microeconomic foundations; advantages in counterfactuals and unusual conditions.
  - Challenges: no consensus fiscal rule, linearization rules out state-dependent multipliers, sensitivity to parameter choices, calibration vs estimation differences.
- Guidance on choosing estimates:
  - Empirical studies useful for “average” circumstances; narrative approaches considered higher-quality estimates.
  - Model-based multipliers may be more useful when current circumstances differ significantly from historical averages (e.g., high share of credit-constrained agents, ZLB).
- Practical difficulties of narrative approach:
  - Benchmark of “unchanged policy” ambiguous; announced-and-reversed measures complicate count; quantification methodologies vary and may be nontransparent; yield of administrative measures hard to assess; official sources can conflict.

*Source: _wp1493 — 1. Narrative Approach: First-Year Tax Multipliers (chapter/section content provided).*

### 1. Narrative Approach: First-Year Tax Multipliers ...................................................................7

### 1. Narrative Approach: First-Year Tax Multipliers

### Definitions and purpose
- Fiscal multipliers measure the short-term impact of discretionary fiscal policy on output; generally defined as the ratio of a change in output (ΔY) to a discretionary change in government spending or tax revenue (ΔG or ΔT).  
- Impact multiplier = (∆Y(t))/(∆G(t)). Multiplier at horizon i = (∆Y(t+i))/(∆G(t)).  
- “Overall” multiplier: output response to an unspecified fiscal shock. “Revenue” (“spending”) multiplier: output response to a discretionary change in revenue (spending).  
- This paper refers to multipliers as one-year multipliers unless otherwise stated.  
- Better estimation and use of multipliers can improve macroeconomic forecast accuracy and fiscal policy design. Under-estimation of multipliers early in the crisis contributed significantly to growth forecast errors (Blanchard and Leigh, 2013).  
- Estimation challenges: two-way relationships between fiscal variables and output (automatic stabilizers and discretionary responses), identification of exogenous fiscal shocks, and data limitations for econometric and model-based methods (SVAR, DSGE).  
- Where no reliable estimate is available, the paper proposes a “bucket approach” to group countries with similar expected multiplier values based on characteristics.

### Narrative approach: methodological advantage
- The narrative approach seeks to identify exogenous fiscal shocks directly, rather than filtering out automatic stabilizers via output elasticities (as in structural VARs).  
- On taxes: narrative studies use estimates of fiscal measures extracted from budget documents and exclude measures taken in response to short-term macroeconomic fluctuations.  
- On spending: some narrative studies use news about future military spending as a measure of exogenous spending shocks (military spending assumed determined by wars/foreign policy, not the state of the economy).

### Main empirical findings from narrative studies — First-year tax multipliers (Table 1)
- Reported estimates correspond to the response of output in percent following an exogenous tax shock of 1 percent of GDP. First year multiplier unless otherwise noted.
- Cloyne (2013), United Kingdom: 0.6 — Maximum multiplier reached after 10 quarters (about 2.5).  
- Favero and Giavazzi (2012), United States: 0.7 — Maximum multiplier reached after 9 quarters (just below 1).  
- Guajardo and others (2014), Panel of OECD Countries: 1 — After two years, multiplier reaches about 3.  
- Hayo and Uhl (2014), Germany: 1 — Maximum multiplier after 8 quarters (about 2.4).  
- Mertens and Ravn (2013), United States: 1 — Maximum multiplier reached after 8 quarters (about 2).  
- Romer and Romer (2010), United States: 1.2 — Maximum multiplier reached after 10 quarters (around 3).

### Narrative studies on spending multipliers — First-year and near-term estimates (Table 2)
- Reported estimates correspond to the response of output in percent following an exogenous spending shock of 1 percent of GDP. First year multiplier unless otherwise noted.
- Barro and Redlick (2011): 0.4–0.6 — Based on U.S. defense spending news; 1917–2006; lower multiplier for temporary spending changes, higher end of range for permanent spending changes.  
- Guajardo and others (2014): 0.3 — Overall spending shock. After two years, multiplier reaches about 1.  
- Hall (2009): 0.6 — Based on U.S. defense spending news; 1930–2008.  
- Owyang, Ramey, Zubairy (2013): United States: 0.8; Canada: 0.4–1.6 — Based on U.S. defense spending news; 1890–2010 for the United States, 1921–2011 for Canada. Two year multipliers; in Canada range reflects low unemployment (low multiplier) and high unemployment (high multiplier) regimes. In the United States, multipliers do not differ significantly across regimes.  
- Ramey (2011): 1.1–1.2 — Based on U.S. defense spending news; 1939–2008. "Defense-news" reflect changes in the expected present value of government spending in response to military events; peak multiplier after 6 quarters.

### Key pattern highlighted by narrative evidence
- Narrative studies challenge the conventional view that spending multipliers are always larger than revenue multipliers—some narrative tax multipliers are as large or larger than spending multipliers in first-year and peak responses.

### Multipliers in EMEs and LICs (summary)
- Theoretical ambiguity: it is unclear whether multipliers in EMEs and LICs should be higher or lower than in AEs. Table 3 lists factors that can either increase or decrease multipliers in EMEs and LICs.
- Factors increasing the multiplier in EMEs and LICs include:
  - Less consumption smoothing when liquidity constraints and weaker forward-looking behavior prevail.  
  - Larger room for credibility and confidence effects with higher interest spreads.  
  - Smaller economies and less openness (in some cases) reduce demand leakage.  
- Factors decreasing the multiplier in EMEs and LICs include:
  - Precautionary saving in more uncertain environments.  
  - Inefficiencies in public expenditure management and revenue administration.  
  - Lower automatic stabilizers.  
  - Greater openness and small size causing demand leakage through imports.  
  - Lower government debt in some countries reducing scope for demand effects.
- Empirical evidence (limited) suggests multipliers in EMEs and LICs are smaller than in AEs (Estevão and Samake, 2013; Ilzetzki and others, 2013; Ilzetzki, 2011; IMF, 2008; Kraay, 2012). Some studies find negative multipliers in the longer term or when public debt is high.
- Instrument-specific short-term estimates in EMEs: Ilzetzki (2011) finds spending multipliers range from 0.1 to 0.3 and revenue multipliers lie between 0.2 and 0.4 in the short term. Ilzetzki and others (2013) find a combination of government consumption multiplier of zero and a positive government investment multiplier of 0.6 explains a low overall spending multiplier.

### Determinants of multiplier size
- Two classes of determinants:
  - Structural country characteristics that influence response in “normal times.”  
  - Conjunctural/temporary factors (cyclical or policy-related) that make multipliers deviate from normal levels.

- Structural characteristics identified:
  - Trade openness: Lower propensity to import → higher fiscal multipliers.  
  - Labor market rigidity: More rigid labor markets → larger multipliers (reduced wage flexibility amplifies demand shocks).  
  - Size of automatic stabilizers: Larger automatic stabilizers → lower multipliers.  
  - Exchange rate regime: Flexible exchange rates → smaller multipliers (exchange rate movements offset policy impact).  
  - Debt level: High-debt countries → generally lower multipliers (credibility/confidence effects, interest-rate risk premium).  
  - Public expenditure management and revenue administration: Inefficiencies → smaller multipliers.

- Conjunctural factors:
  - State of the business cycle: Multipliers generally larger in downturns than in expansions. A stimulus is less effective in an expansion due to crowding out; a consolidation is more costly in a downturn because credit-constrained agents cannot smooth consumption. Evidence suggests downturns increase multipliers more than expansions decrease them.
  - Degree of monetary accommodation: Expansionary monetary policy lowers the contractionary impact of fiscal consolidation; multipliers can be much larger when monetary policy is impaired (e.g., at the zero lower bound, ZLB). Effects at the ZLB are conditional on factors such as shock size and implementation lags.

### Empirical evidence over the business cycle (selected results from Table 4)
- Reported multipliers vary by study, horizon, and cyclical state. Selected entries:
  - Auerbach and Gorodnichenko (2012a), United States, 6 quarters: Expansion = 0; Linear = 0.4; Recession = 1.7 (spending).  
  - Auerbach and Gorodnichenko (2012b), OECD, first year: Expansion = −0.2; Linear = 0.2; Recession = 0.5 (spending).  
  - Auerbach and Gorodnichenko (2014), Japan, 4 quarters: Expansion = 1; Linear = 1.2; Recession = 2.4 (spending).  
  - Batini and others (2012), 4 quarters: Expansion = 0.82; Linear = 0.93; Recession = 2.08 (spending); Expansion = −0.08; Linear = −0.17; Recession = 0.08 (revenue).  
  - Baum and others (2012), 4 quarters: Expansion = 0.72; Linear = 0.79; Recession = 1.22 (spending); Expansion = −0.04; Linear = 0.29; Recession = 0.35 (revenue).  
  - Canzoneri and others (2012), DSGE, United States, impact multiplier: Expansion = 0.89; Linear = 1.3; Recession = 2.25 (spending).  
  - Hernandez de Cos and Moral-Benito (2013), Spain, 4 quarters: Expansion = 0.6; Linear = 0.65; Recession = 1.3 (spending).

### Zero Lower Bound (ZLB) and government spending multipliers
- Most literature focusing on temporary increases in government purchases finds the multiplier at the ZLB exceeds the “normal times” multiplier by a large margin (conditional on factors such as shock size and implementation timing).  
- Erceg and Lindé (2010): size of the shock matters at the ZLB; larger discretionary spending increases shorten the duration at the ZLB and can lower the multiplier.  
- Christiano and others (2011): implementation lags reduce the multiplier at the ZLB; for a significantly larger multiplier, the ZLB must still be present when the spending shock hits.  
- Results on tax measures at the ZLB are less conclusive; for example, Eggertson (2010) finds labor and capital tax cuts at the ZLB can have contractionary effects (negative multipliers) in contrast to other findings on spending.

### Practical implications and the bucket approach
- Given data limitations and methodological challenges, the paper proposes the “bucket approach” to guesstimate one-year multipliers for countries lacking reliable estimates by grouping countries with similar structural and conjunctural characteristics.  
- The ranges and determinants summarized here feed into the bucket approach to derive multipliers for AEs, EMEs, and LICs in the absence of country-specific empirical estimates.

*Source: _wp1493 - 1. Narrative Approach: First-Year Tax Multipliers (chapter/section content provided).*

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### Persistence of Fiscal Multipliers
- Output effects of an exogenous fiscal shock generally vanish within five years; the effect usually has an inverted U shape with the maximum impact occurring in the second year.
- Based on Mineshima and others (2014), the second-year multiplier is, on average, 10–30 percent higher than in the first-year.
- Determinants of persistence:
  - Persistence of the fiscal shock (temporary vs permanent): temporary measures tend not to have effects beyond the duration of the shock; permanent measures may be more persistent but generally do not last more than five years.
  - Type of fiscal instrument:
    - Permanent discretionary changes in indirect taxes, government consumption, and transfers typically have short-term output effects, vanishing within five years.
    - Permanent discretionary changes in public investment or corporate taxes can have longer-lasting or even permanent effects, with multipliers increasing after the first year toward long-term values.
  - Conjunctural factors:
    - Fiscal shocks in recessions or when production is below potential may have more persistent effects because of hysteresis or limited borrowing by credit-constrained agents.
    - Multipliers increase if the initial spending shock occurs in a recession and decline if it occurs in an expansion.
  - Monetary policy response:
    - Persistence is higher if monetary policy does not offset fiscal shocks.
    - A two-year public consumption stimulus can have a positive effect on output of up to five years if there is no monetary policy response; if monetary policy offsets the fiscal shock, effects do not last beyond the duration of the fiscal stimulus.

### Government Spending Multipliers and the Zero Lower Bound (ZLB)
- Table 5 reported model-based ZLB effects (impact multipliers for temporary increases in spending in the United States):
  - Christiano and others (2011): No ZLB 1.1; ZLB 3.7. Note: multiplier at ZLB assumes policy implemented at time t when ZLB begins to bind; an implementation lag of 1 period reduces the multiplier to 1.5.
  - Eggertson (2010): No ZLB 0.5; ZLB 2.3.
  - Erceg and Linde (2010): No ZLB 1; ZLB 4. ZLB multiplier of 4 is based on a temporary spending increase of 1 percent of GDP and ZLB duration of 8 quarters. Larger positive spending shocks are associated with lower multipliers since they shorten ZLB duration; e.g., for a government spending increase above 3.5 percent of GDP, the multiplier declines to 1.5. A cut in spending can increase the multiplier; e.g., a cut of 1 percent of GDP is associated with a multiplier of up to 6.

### The Bucket Approach (Selecting First-Year Overall Multipliers)
- Purpose: For countries without readily available multipliers, group countries into three buckets (low, medium, high) based on structural characteristics likely to affect multipliers.
- Step 1 — Scoring (assign 1 point per characteristic present):
  - Low trade openness: ratio of imports to domestic demand below 30 percent on average over the past five years.
  - High labor market rigidities: labor market rigidity measures roughly 0.8–1 on indices ranging from 0-weak to 1-strong.
  - Small automatic stabilizers: ratio of public spending to nominal GDP below 0.40.
  - Fixed or quasi-fixed exchange rate regime: exchange rate arrangement not fully flexible (AREAER categories listed).
  - Low/safe public debt level: gross government debt below a level considered “safe” (AEs: 100 percent of GDP; EMEs: 40 percent of GDP).
  - Effective public expenditure management and revenue administration: assessed via PEFA and tax productivity measures.
- Step 2 — Bucket assignment (equal weights for characteristics):
  - Total scores 0 to 3: Low multipliers.
  - Total scores 3 or 4: Medium multipliers.
  - Total scores 4 to 6: Large multipliers.
  - Table 6 multiplier ranges (Normal Times):
    - Low multiplier 0.1–0.3
    - Medium multiplier 0.4–0.6
    - High multiplier 0.7–1.0
- Step 3 — Conjunctural adjustments (scale up/down range):
  - Cycle adjustment:
    - If economy at lowest point of cycle (maximum negative output gap based on historical patterns), increase both lower and upper bound by 60 percent.
    - If economy at peak (maximum positive output gap), decrease both bounds by 40 percent.
    - If output gap is zero, no adjustment. Interpolate for intermediate cases.
  - Monetary policy stance adjustment:
    - If monetary policy is at the effective lower bound and fully constrained, increase both bounds by 30 percent.
    - Interpolate between 0 and 30 percent if monetary policy is partially constrained.
- Multiplicative formula to combine effects:
  - M = M_NT * (1+Cycle) * (1+Mon)
    - Where M is final multiplier estimate, M_NT is the “normal times” multiplier derived from step 2, Cycle ranges from −0.4 to +0.6, and Mon ranges from 0 to 0.3.
- Resulting first-year multipliers under various combinations may vary from about 0 to 2.
- Notes on calibration:
  - Calibration based on AE studies but intended to be applied to EMEs and LICs with judgment.
  - No separate adjustment for fiscal package composition is introduced here.

### Illustration: United States Example
- Scoring based on structural characteristics for the United States:
  - Relatively Closed 1
  - Rigid Labor Markets 0
  - Small Automatic Stabilizers 1
  - Fixed Exchange Rate Regime 0
  - Safe Government Debt 1
  - Effective expenditure/revenue management 1
  - Total score 4
- Bucket assignment and scaling (assuming negative output gap; U.S. public debt treated as “safe”):
  - Score 4 Medium (0.4–0.6) → Multiplier after scaling 0.6–0.9 (with +0.3 cycle and +0.1 constrained monetary policy)
  - Score 4 High (0.7–1) → Multiplier after scaling 1.0–1.4
- Comparison with literature:
  - Auerbach and Gorodnichenko (2012a) estimate a first-year expenditure multiplier of about 1.4 in recessions.
  - Baum and others (2012) find an overall downturn multiplier of 0.9 (assuming half adjustment falls on spending).
  - Batini and others (2012) find a multiplier of 1.2 with the same assumption.

### Caveats, Extensions, and Practical Guidance
- The bucket approach is rule-of-thumb guidance and should not be applied mechanically; calibrated largely on AE studies.
- Use judgment and country-specific priors to adjust multipliers. Examples where further adjustments may be justified:
  - Large government-controlled economies with small private sectors: adjust multiplier upwards.
  - De jure flexible exchange rate regimes where monetary policy is constrained by currency mismatches: adjust upwards.
  - Highly credible fiscal adjustment: adjust multiplier downwards (confidence effects may reduce consolidation costs).
- Persistence for subsequent years:
  - Assume decline to zero in multiplier size over five years, with a potentially higher multiplier in the second year (10–30 percent relative to the first-year).

### Conclusions
- Fiscal multipliers are key inputs for assessing the short-term macroeconomic impact of fiscal policy and improve transparency and forecasting.
- Two main contributions of the paper:
  - Overview of literature on short-term multipliers and their determinants (structural and temporary factors), including findings for EMEs and LICs where multipliers tend to be lower.
  - Practical guidance (the bucket approach) to select multipliers where country-specific estimates are unavailable; the method identifies ranges and accounts for environmental factors but requires judgment and consideration of data and institutional specifics.
- Typical empirical finding: discretionary fiscal policy effects on output typically vanish within five years, with an inverted U profile and peak impact usually in the second year.

*Source: _wp1493 - 0.7 N/A 0.8 N/A N/A N/A*

### APPENDIX I. MULTIPLIER ESTIMATION TECHNIQUES IN THE LITERATURE

### APPENDIX I. MULTIPLIER ESTIMATION TECHNIQUES IN THE LITERATURE

### Overview
- Two main methods to derive fiscal multipliers: empirical estimation and model-based approaches.
- Both techniques typically report separate multipliers for revenue and expenditure measures.
- 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 (example: OECD regularly publishes model-based estimates).
- In most studies, sector coverage is the general government.

### Empirical estimations
- Methodology:
  - Vector autoregressive (VAR) models, and structural VARs (SVARs), are widely used to estimate fiscal multipliers.
  - Variables typically included: revenue, spending, output, interest rate and inflation.
  - Since Blanchard and Perotti (2002), a common approach is structural identification (SVAR) to extract structural shocks and estimate their impact on GDP.
- Advantages:
  - Use country-specific data to explore the relationship between fiscal policy and output.
- Shortcomings and limitations:
  - Structural identification may fail to capture purely exogenous fiscal shocks (example: does not filter out asset and commodity price movements).
  - SVARs provide an estimate of the average response of output to exogenous fiscal shocks based on past information; if a country has undergone major structural changes, the “average” multiplier may not measure the effect of fiscal policy today accurately.
  - SVARs are generally linear and do not capture state-contingent multipliers.
- Recent developments:
  - Narrative or action-based approaches use direct estimates of fiscal measures from government documents to identify exogenous fiscal shocks.
  - Some studies combine narrative approaches and SVARs by including tax shocks derived from budget documents into the SVAR framework (Favero and Giavazzi, 2012; and Mertens and Ravn, 2012).
  - Non-linear SVARs have been employed 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 (DSGE and New Keynesian models)
- Methodology and advantages:
  - New Keynesian macroeconomic models, particularly DSGE models, are commonly used for simulating the impact of fiscal policy on growth.
  - DSGE models describe the behavior of the economy as a whole by analyzing the interaction and combination of many microeconomic decisions (contrast with VARs that look at a few variables).
  - Coenen and others (2012) review fiscal multipliers generated in seven DSGE models.
- Challenges and limitations:
  - Little consensus about fiscal policy modeling; unlike the Taylor rule for monetary policy, there is no generally accepted fiscal rule to include in a DSGE.
  - Many DSGE models are based on linearized equations, thereby ruling out state-dependent multipliers.
  - Simulation results tend to be sensitive to choice of parameters (examples: degree of price and wage rigidities, habit persistence, investment adjustment cost, and proportion of liquidity-constrained agents).
  - Multipliers depend on specific modeling assumptions, especially if models are calibrated rather than estimated.
  - When the same model is used across countries, results tend to show less dispersion than empirical studies.

### Guidance on choosing between alternative multiplier estimates
- Rule of thumb when several estimates are available:
  - Empirical studies (usually long-period estimations) are most useful to estimate multipliers under “average” or “normal” circumstances (explicit example: small output gap, interest rates not constrained by the zero lower bound...), with narrative approaches generally considered higher-quality estimates.
  - If current circumstances differ significantly from those prevailing during the empirical estimation period, model-based multipliers may be more useful because they can reflect unusual conditions (example: a high proportion of credit-constrained agents) or conditions with few historical precedents (example: a zero lower bound on interest rates).

### Practical difficulties of the narrative (action-based) approach
- Fiscal measures are assessed against a benchmark of “unchanged policy,” which is not always clearly defined; interpretation issues arise (example: freezing government wages could be considered tightening or expansionary depending on assumptions about inflation or productivity).
- If measures are announced for the future and then reversed, either 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 always transparent and may be incorrect; methodology may differ across countries and be influenced by data availability and political decisions.
- Quantification may be based on wrong macro assumptions; the yield of administrative measures is particularly difficult to assess.
- Conflicting evidence from various official sources may necessitate building a “consensus estimate” of the size of fiscal shocks.

*Source: APPENDIX I. MULTIPLIER ESTIMATION TECHNIQUES IN THE LITERATURE*

### chapter III of Public Finances in EMU (Brussels).

### chapter III of Public Finances in EMU (Brussels)

### Fiscal multipliers and methodological contributions
- Espinoza, R., and A. Senhadji, 2011, “How Strong are Fiscal Multipliers in the GCC? An Empirical Investigation,” IMF Working Paper 11/61 (Washington: International Monetary Fund).
- Favero, C., and F. Giavazzi, 2012, “Measuring Tax Multipliers: The Narrative Method in Fiscal VARs,” American Economic Journal: Economic Policy, Vol. 4, No. 2, pp. 69–94.
- Forni, L., L. Monteforte, and L. Sessa, 2009, “The general equilibrium effects of fiscal policy: Estimates for the Euro area,” Journal of Public Economics, Vol. 93 No. 3–4, pp.559–85.
- Giavazzi, F., and M. Pagano, 1990, “Can Severe Fiscal Contractions Be Expansionary? Tales of Two Small European Countries,” NBER Macroeconomics Annual 1990, Volume 5, pp. 75–122.
- Ilzetzki E., E. G. Mendoza and C. A. Vegh, 2013, “How Big (Small?) Are Fiscal Multipliers?” Journal of Monetary Economics, Vol. 60, pp. 239–54.
- Mertens, R. and M. O Ravn, 2012, A Reconciliation of SVAR and Narrative Estimates of Tax Multipliers, CEPR Discussion Paper, No. 8973 (London: Center for Economic Policy Research).
- Mertens, R. and M. O Ravn, 2013, “The Dynamic Effects of Personal and Corporate Income Taxes in the United States,” American Economic Review, Vol. 103, pp. 1212–47.
- Ramey, V., 2011, “Identifying Government Spending Shocks: It’s all in the Timing,” Quarterly Journal of Economics, Vol. 126, No. 1, pp. 1–50.
- Romer, C.D., and D.H. Romer, 2010, “The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks,” American Economic Review, Vol. 100, pp. 763–801.
- Woodford, M., 2011, “Simple Analytics of the Government Expenditure Multiplier,” American Economic Journal: Macroeconomics, Vol. 3, No. 1, pp.1–35.
- Favero, C., and F. Giavazzi, 2012, “Measuring Tax Multipliers: The Narrative Method in Fiscal VARs,” American Economic Journal: Economic Policy, Vol. 4, No. 2, pp. 69–94.

### Country and regional empirical studies
- Gonzales-Garcia, J., A. Lemus, and M. Mrkaic, 2013, “Fiscal Multipliers in the ECCU,” IMF Working Paper 13/117 (Washington: International Monetary Fund).
- Gorodnichenko, Y., E.G. Mendoza, and L.L. Tesar, 2012, “The Finnish Great Depression: From Russia with Love”, American Economic Review, Vol. 102, No. 4, pp. 1619–44.
- Guajardo J., D. Leigh, and A. Pescatori, 2014, “Expansionary Austerity: International Evidence,” Journal of the European Economic Association (forthcoming).
- Hayo, B. and Uhl, M., 2013, “The Macroeconomic Effects of Legislated Tax Changes in Germany,” Oxford Economic Papers, 1of 22 (Oxford: Oxford University).
- Hernández de Cos, P., and Moral-Benito, E., 2013, “Fiscal Multipliers in Turbulent times: The Case of Spain,” Bank of Spain Working Paper 1309 (Madrid: Bank of Spain).
- Jooste, C., 2012, “Analyzing the Effects of Fiscal Policy Shocks in the South African Economy,” Department of Economics Working Paper 2012-06 (Pretoria: University of Pretoria).
- Kirchner, M., J. Cimadomo and S. Hauptmeier, 2010, “Transmission Of Government Spending Shocks In The Euro Area: Time Variation and Driving Forces,” ECB Working Paper Series 1219 (Frankfurt: European Central Bank).
- Muir, D., and A. Weber, 2013, “Fiscal Multipliers in Bulgaria: Low But Still Relevant,” IMF Working Paper 13/49 (Washington: International Monetary Fund).
- Rafiq, S., and A. Zeufack, 2012, “Fiscal Multipliers over the Growth Cycle: Evidence from Malaysia, World Bank Policy Research Working Paper 5982 (Washington: World Bank).
- Riera-Crichton, R., C. Veigh, and G. Vultein, 2012, “Tax Multipliers: Pitfall in Measurement and Identification,” NBER Working Paper No. 18497 (Cambridge: National Bureau of Economic Research).
- Šimović, H. and M. Deskar-Škrbić, 2013. “Dynamic Effects of Fiscal Policy and Fiscal Multipliers in Croatia.” Journal of Economics and Business, Vol. 31, pp. 55–78.
- Stoian, A., 2012, “The Macroeconomic Effects of Fiscal Policy in Romania,” Presentation. www.finsys.rau.ro/docs/Stoian%20Anca.pdf.
- Tang, H. C., P. Liu, and E. C. Cheung, 2010, “Changing Impact of Fiscal Policy on Selected ASEAN Countries.” ADB Working Paper, No. 70 (Washington: Asian Development Bank).
- Wang, X., and Y. Wen, 2013, “Is Government Spending a Free Lunch? — Evidence from China, Federal Reserve Bank of St. Louis Working Paper Series, Working Paper 2013-013A (St. Louis: U.S. Federal Reserve Bank).
- Gonzales-Garcia, J., A. Lemus, and M. Mrkaic, 2013, “Fiscal Multipliers in the ECCU,” IMF Working Paper 13/117 (Washington: International Monetary Fund).

### Fiscal consolidation, debt dynamics, and policy discussion
- Estevão, M and I. Samake, 2013, “The Economic Effects of Fiscal Consolidation with Debt Feedback,” IMF Working Paper 13/136 (Washington: International Monetary Fund).
- Eyraud, L., and A. Weber, 2012, “Debt Reduction during Fiscal Consolidations: The role of Fiscal Multipliers,” unpublished paper presented at the IMF surveillance meeting seminar of April 10, 2012.
- Eyraud, L., and A. Weber, 2013, “The Challenge of Debt Reduction during Fiscal Consolidation,” IMF Working Paper 13/67 (Washington: International Monetary Fund).
- Freedman, C., M. Kumhof, D. Laxton, and J. Lee, 2009, “The Case for Global Fiscal Stimulus,” IMF Staff Position Note 09/03 (Washington: International Monetary Fund).
- Ghosh, A., and L. Rahman, 2008, “The Impact of Fiscal Adjustment on Economic Activity” (Washington: International Monetary Fund, unpublished).
- Perotti, R., 2012, “The “Austerity Myth: Gain without Pain?” in Fiscal Policy after the Financial Crisis (Cambridge: National Bureau of Economic Research).
- International Monetary Fund, 2008, World Economic Outlook, October, Chapter 5, “Fiscal Policy as a Countercyclical Tool,” (Washington).
- International Monetary Fund, 2010, World Economic Outlook, October, Chapter 3, “Will It Hurt? Macroeconomic Effects of Fiscal Consolidation,” (Washington).
- International Monetary Fund, 2011, World Economic Outlook, September, Chapter 4, “Separated at Birth? The Twin Budget and Trade Balances,” (Washington).
- International Monetary Fund, 2012, Fiscal Monitor, October (Washington).
- International Monetary Fund, 2013, “Guidance Note on Multipliers,” (Washington, unpublished).

### Specialized topics and supporting analyses
- Fedelino, A., A. Ivanova, and M. Horton, 2009, “Computing Cyclically Adjusted Balances and Automatic Stabilizers,” IMF Technical Notes and Manuals.
- Hall, R. E., 2009, “By How Much Does GDP Rise If the Government Buys More Output?” Brookings Papers on Economic Activity, pp. 183–231.
- Ilzetzki, E., 2011, “Fiscal Policy and Debt Dynamics in Developing Countries,” Policy Research Working Paper Series 5666 (Washington: The World Bank).
- Kraay, A., 2012, “How large is the Government Spending Multiplier? Evidence from World Bank Lending,” Quarterly Journal of Economics, Vol. 127, No. 2, pp. 829–87.
- Mehra, Y., 2001, “The Wealth Effect in Empirical Life-Cycle Aggregate Consumption Equations,” FRB Richmond Economic Quarterly, Vol. 87, No. 2, pp. 45–68.
- Mineshima, A., M. Poplawski-Ribeiro, and A. Weber, 2014, “Fiscal Multipliers,” in Post-Crisis Fiscal Policy, ed. by C. Cottarelli, P. Gerson, and A. Senhadji (Cambridge: MIT Press, forthcoming).
- Owyang, M.T., V. A. Ramey, and S. Zubairy, 2013, “Are Government Spending Multipliers Greater During Periods of Slack? Evidence from 20th Century Historical Data,” NBER Working Paper 18769 (Cambridge: National Bureau of Economic Research).
- Perotti, R., 2004, “Public Investment: Another (Different) Look,” IGIER (Innocenzo Gasparini Institute for Economic Research) Working Paper 277 (Bocconi: Bocconi University).
- Riera-Crichton, R., C. Veigh, and G. Vultein, 2012, “Tax Multipliers: Pitfall in Measurement and Identification,” NBER Working Paper No. 18497 (Cambridge: National Bureau of Economic Research).
- Romer, C.D., 2011, “What Do We Know About the Effects of Fiscal Policy? Separating Evidence From Ideology,” Hamilton College, November 7, 2011.
- Spilimbergo, A., S. Symansky, and M. Schindler, 2009, “Fiscal Multipliers,” IMF Staff Position Note, SPN/09/11 (Washington: International Monetary Fund).
- Tang, H. C., P. Liu, and E. C. Cheung, 2010, “Changing Impact of Fiscal Policy on Selected ASEAN Countries.” ADB Working Paper, No. 70 (Washington: Asian Development Bank).
- Wang, X., and Y. Wen, 2013, “Is Government Spending a Free Lunch? — Evidence from China, Federal Reserve Bank of St. Louis Working Paper Series, Working Paper 2013-013A (St. Louis: U.S. Federal Reserve Bank).

*chapter III of Public Finances in EMU (Brussels).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2014/_wp1493.pdf_