Uncertainty and Public Investment Multipliers: The Role of Economic Confidence

IMF Working Papers, November 12, 2021

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Author: William Gbohoui
Date: November 12, 2021
Core question: How does macroeconomic uncertainty affect the fiscal multiplier of public investment?
Theoretical channels:
- Uncertainty can reduce the multiplier if the private sector becomes more cautious and does not respond to the fiscal stimulus.
- Uncertainty can increase the multiplier if public investment shocks improve private agents’ expectations about future economic outlook and lead to larger private spending.

Using the disagreement about GDP forecasts as a proxy for uncertainty, the paper finds:
- Unexpected increases in public investment have larger and longer-lasting effects on output, investment, and employment during periods of high uncertainty.
- Multipliers are above 2 during periods of high uncertainty.
- The larger multipliers are not driven by economic slack.
- Public investment shocks boost private sector confidence during heightened uncertainty, raising expectations about future economic development and magnifying private sector response to the initial stimulus.

Proxy for uncertainty: disagreement about GDP forecasts.
Amplification channel: public investment shocks improve private sector expectations about future economic outlook, which in turn increases private spending and strengthens the multiplier during high uncertainty episodes.
Alternative channel considered: private sector caution under uncertainty could dampen the multiplier, but empirical results support the expectation-boosting channel in the contexts analyzed.

Public investment can be an effective countercyclical tool during periods of heightened macroeconomic uncertainty by:
- Producing multipliers above 2 on output, investment, and employment.
- Strengthening private sector confidence and expectations, thereby crowding in private spending.
Policy design should consider the state of economic confidence: the same public investment shocks have markedly different impacts depending on prevailing uncertainty.

Empirical strategy relies on using forecast disagreement about GDP as a measure of macroeconomic uncertainty.
The focus is on unexpected increases (shocks) in public investment and their dynamic effects on macroeconomic aggregates and private sector expectations.