Fiscal Policy Multipliers in Small States

IMF Working Papers, March 26, 2019

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Government debt in many small states has risen beyond sustainable levels and some governments are considering fiscal consolidation.
The paper estimates fiscal policy multipliers for small states using two distinct models:
- an empirical forecast error model with data from 23 small states across the world; and
- a Dynamic Stochastic General Equilibrium (DSGE) model calibrated to a hypothetical small state’s economy.

Fiscal policy using government current primary spending is ineffective in affecting the level of GDP over the medium term.
Government investment is very potent in small states in affecting the level of their GDP over the medium term.
These results are robust to different model specifications and characteristics of small states.
For the short term:
- Multipliers for government current primary spending are larger.
- Short-term multipliers are affected by imports as share of GDP, level of government debt, and position of the economy in the business cycle, among other factors.

Inability to affect GDP using current primary spending could be frustrating for policymakers when an expansionary policy is needed.
The ineffectiveness of current primary spending is encouraging at the current juncture when many governments are considering fiscal consolidation.
Prioritizing government investment over current primary spending may be more effective for influencing medium-term GDP in small states.