Fiscal Policy Multipliers in Small States

Abstract

IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. AbstractGovernment debt in many small states has risen beyond sustainable levels and some governments are considering fiscal consolidation. This 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. The results suggest that fiscal policy using government current primary spending is ineffective, but using 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. Inability to affect GDP using current primary spending could be frustrating for policymakers when an expansionary policy is needed, but encouraging at the current juncture when many governments are considering fiscal consolidation. For the short term, however, multipliers for government current primary spending are larger and affected by imports as share of GDP, level of government debt, and position of the economy in the business cycle, among other factors. JEL Classification Numbers; E62; C3

Getting into the Nitty-Gritty of Fiscal Multipliers: Small Details, Big Impacts

“…Perhaps the most striking difference in estimates corresponds to public consumption, with the multipliers from the one-stage approach being much lower than the two-stage estimation. This is in line with, for example, lower multiplier estimates obtained by Alichi et al (2019), Honda, Miyamoto and Taniguchi (2020) or Cacciatore et al (2021), that estimate multipliers using similar one-stage procedures 25 . This shows that results in the literature are in line to what we find if we were using a similar methodology.…”

Empirical estimates of fiscal multipliers for South Africa

“…Several follow-up papers, including Edelberg et al (1999) and Burnside et al (2004), embedded these 'war dates' in VARs, with the narrative series ordered first in a Cholesky decomposition, creating so-called expectations-augmented VARs (or EVARs). 6 EVARs have been expanded to include other measures of expectations, such as forecast errors of professional and/or public sector forecasters, in order to account for the predictable and/or anticipated element of government spending; examples include Auerbach and Gorodnichenko (2012) and Alichi et al (2019), among others. Most of these narrative-based studies found that shocks to government spending (as proxied by changes in military spending) led to increases in GDP and hours worked, at least in the short run, but that it lowered private consumption and investment.…”

“…In a survey of the literature, Ramey (2016) found that most estimates of the government spending multiplier in the developed world vary between 0.6 and 1.5. Much less evidence is available for the developing world, but the scarce empirical literature suggests that multipliers are smaller in emerging-and low-income economies (see, for example, Alichi et al 2019;Batini et al 2014;Estev ao and Samaké 2013;Gnip 2014;Ilzetzki 2011;Ilzetzki et al 2013;IMF 2008;Kraay 2012). Empirical research into spending multipliers for South Africa is even more scarce.…”

Determinants of variation in public investment in emerging Europe

“…The emerging literature on fiscal multipliers strongly suggests that public investment has a significant positive impact on economic growth, both in the high income and in developing countries (see Leeper et al, 2010;Ilzetzki et al, 2013;Eden and Kraay, 2014;Alichi et al, 2019). Many of these studies also indicate that fiscal multipliers associated with public investment are significantly higher than multipliers associated with current expenditures (Ilzetzki et al, 2013).…”

“…Public investment yields a double dividend in terms of economic growth and a decrease in unemployment, as it provides a positive impetus both during its implementation (boosting demand) and after completion (encouraging supply, by reducing the costs and risks of private investment). Many empirical studies show that fiscal multipliers of public investment are rather high, not only in large economies but also in small economies, thus outperforming multipliers of current expenditures (Ilzetzki, 2013;Alichi, 2019).…”