Local Government Spending Multipliers and Financial Distress: Evidence from Japanese Prefectures

Abstract

We estimate local government spending multipliers using annual data for 47 Japanese prefectures during the 1990s. Our main findings are as follows: the average local government spending multiplier is positive and significantly different from zero but not larger than one; there are large and significant differences in the output effects of different types of government expenditures: transfers to firms have the highest multiplier, significantly larger than one, while transfers to households have the lowest multiplier, significantly below zero; firms' financial distress has a significant negative effect on the local government spending multiplier, in contrast to economic slack that has a significant positive effect.The effectiveness of government spending during times of financial crisis is an intensely debated issue. Both in academic and policy circles, the views are split on how effective government spending is in resuscitating the economy. Fiscal conservatives warn that large increases in government spending can lead to an unsustainable increase in the stock of public debt and caution therefore about the adverse effects that an expansionary fiscal stance can have on the economy in the long run; see, for example, Auerbach and Gale (2010). Yet even from a short-run, business-cycle perspective there is little consensus among macroeconomists on whether fiscal policy is effective in stimulating the economy; see Hall (2009), andCogan et al. (2010) for an overview of the literature. Most of the academic debate is theoretical in nature and, so far, there is little evidence from rigorous econometric analysis on the size of the government spending multiplier during times of financial crisis.In this article we seek to make an empirical contribution to the debate on whether government expenditures are effective in stimulating economic activity during times of financial crisis by using a rich dataset of regional government expenditures in JapanWe are grateful to the editor and three anonymous referees for very helpful comments and suggestions. We also thank

Regional Transfers

“…As it did not cross the threshold, FPM transfers fell from R$1, 204, 762 to R$1, 111, 936, as in 2003 there was a brief recession due to political turmoil caused by the national election that lowered the size of FPM program. 9 The FPM coecients are based on yearly population estimates produced by the federal statistical agency, IBGE -Instituto Brasileiro de Geograa e Estatistica (Brazilian Institute of Geography and Statistics) -and supervised by a federal court. IBGE calculates municipal population for non-census years taking into consideration past censuses, regional birth and death rates, migration trends and other features using a publicly known methodology.…”

“…IBGE calculates municipal population for non-census years taking into consideration past censuses, regional birth and death rates, migration trends and other features using a publicly known methodology. The budget is approved by municipal councils by the end of the year and FPM funds are transferred during year t. 9 In the Appendix we exemplify the non-linear allocation mechanism of federal transfers discussing four additional examples. All monetary values throughout the paper are in Brazilian Reais (BRL) in constant prices of 1998.…”

“…As before we estimate specications in rst-dierences. Appendix Table 23 reports the log-dierence specications in columns (1)- (3), as well as OLS and LAD dierence specications in (4)- (9). Changes in federal transfers and municipal government spending are signicantly correlated with changes in private sector employment and earnings.…”

Is Abe's Fiscal Policy Ricardian? What Does the Fiscal Theory of Prices Mean for Japan?

“…In the literature on fiscal stimulus, Gorodnichenko (2013, 2014), Bruckner and Tuladhar (2014), and Miyamoto et al (2017) investigate fiscal multipliers in Japan. Morita (2015) analyzes the stimulation effects of a fiscal policy shock to private consumption.…”

Natural Experiments in Macroeconomics

“…However, the analysis in Shoag (2013) focuses on the Great Recession years , whereas Shoag (2015 exploits information from 1987 to 2008. Brückner and Tuladhar (2014) also analyze a local fiscal multiplier using data from Japanese Prefectures. Whereas their study shares the use of year and region fixed effects with the studies cited above, it addresses the issue of endogeneity of local government expenditures by using a system GMM approach.…”