What Determines Government Spending Multipliers?

IMF Working Papers, June 1, 2012

Source details

Research question: How do the effects of government spending vary with the economic environment?
Sample and scope: Panel of OECD countries.
Main approach: Identify fiscal shocks as residuals from an estimated spending rule and trace macroeconomic impact under different conditions regarding the exchange rate regime, public indebtedness, and health of the financial system.
Unconditional result: Responses to a positive spending shock broadly confirm earlier findings.
Conditional result highlights:
- Real appreciation and external deficits occur mainly under currency pegs.
- Output and consumption multipliers are unusually high during times of financial crisis.

Identification: Fiscal shocks identified as residuals from an estimated spending rule.
Comparative conditions analyzed:
- Exchange rate regime (currency pegs versus other regimes).
- Public indebtedness.
- Health of the financial system (including financial crisis episodes).
Tracing: Macroeconomic responses to identified spending shocks are traced across these different economic environments.

Conditional responses differ systematically across exchange rate regimes; under currency pegs there is notable:
- Real appreciation.
- External deficits (trade deficits).
Financial crises amplify multipliers:
- Output multiplier: unusually high during times of financial crisis.
- Consumption multiplier: unusually high during times of financial crisis.
Unconditional responses to a positive spending shock are broadly consistent with earlier literature.
Subject tags and keywords (as stated): Exchange rate arrangements, Expenditure, Financial crises, Fiscal policy, Foreign exchange, Real exchange rates; and keywords including exchange rate regime, financial crisis episode, government spending multiplier, transmission mechanism, stimulus package, trade deficit, WP.

Exchange rate regime matters for external adjustment following fiscal expansion: pegged regimes are associated with real appreciation and external deficits post-spending shock.
Financial sector health conditions the size of fiscal multipliers: during financial crises fiscal stimulus may yield larger output and consumption effects.
Implication for fiscal policy design:
- Consider exchange rate regime when assessing external balance effects of fiscal expansion.
- Anticipate larger demand-side effects of spending during financial crises, which may influence the timing and scale of stimulus.