Cyclical Fiscal Multipliers: Policy Mix and Financial Friction Puzzle

IMF Working Papers, May 30, 2025

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Investigates dynamic relationships between U.S. government expenditure multipliers and the economy's cyclical position from 1949 to 2018 using a Time-Varying Parameter Vector Autoregression (TVP-VAR) model.
Challenges existing literature that relies on predefined economic regimes and assumes a stable relationship between fiscal multipliers and business cycles.
Identifies two distinct periods:
- Fiscal multipliers were counter-cyclical from 1949 to the late 1980s.
- A significant decline in multiplier effectiveness during recessions after the late 1980s.
Attributes variations in multiplier effectiveness to the prevailing fiscal-monetary policy mix:
- Higher fiscal multipliers during earlier recessions resulted from sharp shifts toward a fiscally led policy stance.
- Decline in multipliers after the Dot-com recession due to a transition toward a monetary-led policy mix.
Finds particularly low multipliers during the global financial crisis, highlighting an evolving role for financial frictions in the transmission of fiscal policy.

Empirical approach: Time-Varying Parameter Vector Autoregression (TVP-VAR) model.
Sample period: 1949 to 2018.
Focus variables and concepts: U.S. government expenditure multipliers, cyclical position of the economy, fiscal-monetary policy mix, financial frictions, state-dependent multipliers.

Policy mix matters: shifts between fiscally led and monetary-led policy stances materially affect fiscal multiplier size across business cycles.
Recession-targeted fiscal policy is more effective when accompanied by a fiscally led policy stance, as observed from 1949 to the late 1980s.
Monetary-led responses to downturns (post-Dot-com recession) can reduce the effectiveness of fiscal stimulus.
Financial frictions can further dampen fiscal multipliers, as evidenced by particularly low multipliers during the global financial crisis, suggesting the need to account for financial-sector conditions when designing fiscal interventions.

Provides a time-varying, data-driven assessment of state-dependent fiscal multipliers without imposing predefined regime boundaries.
Offers new insights into the interaction between fiscal policy effectiveness and the monetary-fiscal policy mix over long historical horizons.
Highlights the importance of incorporating financial frictions into assessments of fiscal policy transmission.

IMF Working Paper: "Cyclical Fiscal Multipliers: Policy Mix and Financial Friction Puzzle", Zamid Aligishiev and Hamed Ghiaie, May 30, 2025.