Economics
Fiscal Multiplier
The fiscal multiplier measures the impact of government spending or tax changes on overall economic activity. It reflects the extent to which a change in fiscal policy influences aggregate demand and, consequently, economic output. A higher fiscal multiplier indicates that a given change in government spending or taxes has a larger effect on the economy.
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10 Key excerpts on "Fiscal Multiplier"
eBook - PDFAusterity
When It Works and When It Doesn't
- Alberto Alesina, Carlo Favero, Francesco Giavazzi(Authors)
- 2019(Publication Date)
- Princeton University Press(Publisher)
The problem is that an empirical model general enough to incorporate all possible inter-actions between macroeconomic and fiscal policy variables is impossible to estimate because the data available are limited. Thus modeling choices must be made, and they do affect the results. Alternative Ways of Measuring Multipliers Two definitions of multipliers are used in the literature. One looks at the effect on output (or some other macroeconomic variable) of a shift in spending (or taxes) that is not related to the state of the economy, such as during a war. In economists’ jargon an “exogenous” shift in spend-ing, a change that is not caused by the state of the economy or motivated by the need to stimulate the economy. This impact—measured as the ratio of the cumulative change in output to the initial shift in government spending—is computed at various horizons. In other words, assume that in year zero government spending is cut by 1% of GDP: the multiplier is defined as the ratio of the cumulative change in output up to some horizon—say 3 years—divided by the size of the shift in government spending in year zero. The approach has the drawback of overlooking the fact that follow-ing the initial shift, government spending (or taxes) will not remain constant: they will typically keep moving. This suggests an alternative measure: defining “multiplier” the ratio of the cumulative (discounted) output response to the cumulative change in government spending and taxes (also discounted), that is the initial shift, say in spending, plus the shifts in spending that followed the initial exogenous adjustment. This second measure has been advocated by some researchers 3 because 56 Chapter Four it captures the extent to which the size of the multiplier depends on the persistence of fiscal shocks. Although these two measures often produce multipliers of different sizes, when used consistently they rarely result in a different ranking of multipliers.
eBook - ePub- Alfred Schipke, Aliona Cebotari, and Nita Thacker(Authors)
- 2013(Publication Date)
- INTERNATIONAL MONETARY FUND(Publisher)
Fiscal policies play an important role in the management of output fluctuations. A number of countries in the Eastern Caribbean Economic and Monetary Union (OECS/ECCU) used fiscal policies to stimulate economic activity in response to the fallout from the 2008–09 global economic and financial crisis. This chapter quantitatively analyzes the effects of government revenue and expenditures on output dynamics in the union. Given the relatively large share of government in the Eastern Caribbean economies, the currency peg to the U.S. dollar, and the level of development, changes in tax and public expenditure policies may play an important role in output dynamics. Conversely, factors such as the high degree of trade openness and the high level of public indebtedness may weaken the effectiveness of fiscal policy in stimulating economic activity. To assess the possible impact of fiscal policy, this chapter empirically evaluates the Fiscal Multipliers for the group of OECS/ECCU members.The next section discusses the role of Fiscal Multipliers and their usefulness in the design of fiscal policies aimed at managing output fluctuations. The data and methodology are briefly discussed in the subsequent section, which is followed by a section that presents the estimated multipliers.
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The Role of Fiscal Multipliers
Tax and public expenditure multipliers provide a quantitative measure of the change in output resulting from an increase in taxes or government spending, and are key parameters for evaluating the effectiveness of fiscal policies in managing output fluctuations. A public spending multiplier greater than 1 indicates that public expenditure is able to stimulate economic activity and produce a final increase in output larger than the initial increase in public spending. A multiplier less than 1 means that the initial increase in aggregate demand is eroded by effects that counteract the initial unitary increase in public spending. These counteracting effects are often due to the crowding out of productive private sector activities and because part of the intended fiscal impulse translates into higher imports that do not increase output. Taxes are expected to have a negative effect on GDP, so a multiplier of less than –1 would imply that collecting one unit of taxes causes a decrease in economic activity larger than one unit. This outcome could be due to the accompanying distortions created by an increase in taxes or to disincentives for productive private sector activities. A tax multiplier less than zero but more than –1 indicates that economic activity is able to at least partially recover from the initial effect of the extraction of one unit of output in the form of taxes.
eBook - PDF- Ľudovít Ódor(Author)
- 2017(Publication Date)
- Cambridge University Press(Publisher)
Second, multipliers depend on the type of spending or tax change, as well as on a host of other factors: Expected sources and timing of future fiscal financing; whether the initial change in policy was anticipated or not; how monetary policy behaves; what is the state of the cycle when the policy is implemented. There is no such thing as a unique Fiscal Multiplier and the evidence obtained by a specific investigation on the multiplier can be understood only within a general dynamic framework which clearly indicates the specification and identification choices made in that investigation. Bibliography Acconcia, A., Corsetti, G. and Simonelli, S. (2013). Mafia and public spend- ing: evidence on the Fiscal Multiplier from a quasi-experiment. American Economic Review, 104(7), 2185–209. Alesina, A. and Ardagna, S. (2010). Large changes in fiscal policy: taxes versus spending. Tax Policy and the Economy, 24, 35–68. Alesina, A. and Perotti, R. (1997). The welfare state and competitiveness. American Economic Review, 87, 347–66. Alesina, A., Ardagna, S., Perotti, R. and Schiantarelli, F. (2002). Fiscal policy, profits and investment. American Economic Review, 92(3), 571–89. Alesina, A., Barbiero, O., Favero, C. , Giavazzi, F. and Paradisi, M. (2014). Austerity in 2009–2013. Paper prepared for 60th panel meeting of Economic Policy, October 2014. Alesina, A., Favero, C., and Giavazzi, F. (2015). The output effects of fiscal stabilization plans. Journal of International Economics, 96(1), S19–S42. What Do We Know about Fiscal Multipliers? 477 Auerbach, A. and Gorodnichenko, Y. (2012). Measuring the output responses to fiscal policy. American Economic Journal: Economic Policy, 4(2), 1–27. Bachmann, R. and Sims, E. (2011). Confidence and the Transmission of Government Spending Shocks. NBER Working Paper No. 17063, National Bureau of Economic Research, Inc. Barro, R. J. and Redlick, C. J. (2011). Macroeconomic effects from govern- ment purchases and taxes.
eBook - PDF- Irvin Tucker(Author)
- 2018(Publication Date)
- Cengage Learning EMEA(Publisher)
342 PART 3 • The Macroeconomy and Fiscal Policy The key to the amount of real GDP growth achieved from a stimulus package depends on the size of the MPC. What proportion of the government spending increase or tax cut is spent for consumption? The answer means the difference between a deeper or milder recession as well as the speed of recovery. What are estimates of real-world multipliers? In Congressional testimony given in July 2008, Mark Zandi, chief economist for Moody’s Economy.com, provided estimates for the one-year multiplier effect for several fiscal policy options. The spending multiplier varied from 1.36 to 1.73 for different federal government spending programs, such as food stamps, extended unemployment insurance benefits, aid to state governments, or bridges and highways. The tax multiplier also varied from 0.27 to 1.29 for different temporary tax cut plans. Recent studies confirm these estimates and point to the fact that a more complex multiplier is at play, which takes into account a mar-ginal propensity of taxation as well as a marginal propensity to import foreign goods that we do not take into consideration here. 15–1d Using Fiscal Policy to Combat Inflation So far, Keynesian expansionary fiscal policy, born of the Great Depression, has been pre-sented as the cure for an economic downturn. Contractionary fiscal policy, on the other hand, can serve in the fight against inflation. Exhibit 6 shows an economy operating at point E 1 on the classical range of the aggregate supply curve, AS. Hence, this economy is producing the full-employment output of $14 trillion real GDP, and the price level is 220. In this situation, any increase in aggregate demand only causes inflation, while real GDP remains unchanged. Suppose Congress and the president decide to use fiscal policy to reduce the CPI from 220 to 215 because they fear the wrath of voters suffering from the consequences of infla-tion.
eBook - ePubEconomics for Investment Decision Makers
Micro, Macro, and International Economics
- Christopher D. Piros, Jerald E. Pinto(Authors)
- 2013(Publication Date)
- Wiley(Publisher)
- Capital spending plans take longer to formulate and implement, typically over a period of years. For example, building a road or hospital requires detailed planning, legal permissions, and implementation. This is often a valid criticism of an active fiscal policy and was widely heard during the U.S. fiscal stimulus efforts in 2009–2010. On the other hand, such policies add to the productive potential of an economy, unlike a change in personal or indirect taxes. Of course, the slower the impact of a fiscal change, the more likely other exogenous changes will already be influencing the economy before the fiscal change kicks in.
The aforementioned tools may also have expectational effects at least as powerful as the direct effects. The announcement of future income tax rises a year ahead could potentially lead to reduced consumption immediately. Such delayed tax rises were a feature of U.K. fiscal policy of 2009–2010; however, the evidence is anecdotal because spending behavior changed little until the delayed tax changes actually came into force.We may also consider the relative potency of the different fiscal tools. Direct government spending has a far bigger impact on aggregate spending and output than income tax cuts or transfer increases; however, if the latter are directed at the poorest in society (basically, those who spend all their income), then this will give a relatively strong boost. Further discussion and examples of these comparisons are given in Section 4 on the interaction between monetary and fiscal policy.3.2.2. Modeling the Impact of Taxes and Government Spending: The Fiscal Multiplier
The conventional macroeconomic model has government spending, G , adding directly to aggregate demand, AD , and reducing it via taxes, T ; these comprise both indirect taxes on expenditures and direct taxes on factor incomes. Further government spending is increased via the payment of transfer benefits, B
eBook - PDF- Michael Veseth(Author)
- 2014(Publication Date)
- Academic Press(Publisher)
tax expenditures: special tax reductions given for individual spending on approved items. subsidies: government payments to individuals or firms to encourage specific activities. Multiplier Analysis How do government tools affect the economy? The most direct effect is felt on aggregate demand. Changes in government spending, taxing, and transfer payments all end up as changes in aggregate demand. Keynes recognized this fact and added two surprising observations: (1) a change in government spend-ing results in a much larger change in aggregate demand, and (2) we can predict how big the AD change will be. Keynes' insights are based on the analysis of multipliers. An increase of government spending does not just buy missiles or school books or freeway markers. This initial spending sets in motion a chain of con-sumer purchases that raise aggregate demand by far more than the original 182 FISCAL POLICY induced-consumption spending: changes in consumption spending resulting from fiscal policy. government purchase. You can see how this works in the Multiplier Game of Figure 8-1. Suppose government spends $100,000 on red tape (they really use it!). This initial increase in aggregate demand creates $100,000 more income for workers and firms in the red-tape business. What do these folks do with $100,000 more income? The Marginal Propensity to Consume (introduced in Chapter 6) describes how consumption spending changes when income is altered. If the MPC is 60 percent, for example, $60,000 of the additional $100,000 goes to consumption spending (the other $40,000 is saved). Government spending of $100,000 generates induced-consumption expenditures of $60,000. Does the chain end here? No! The $60,000 spent by red-tape workers creates $60,000 more income for people who produce the cars, furniture, and clothing they buy. These folks use the extra $60,000 to spend FIGURE 8-1 THE MULTIPLIER GAME.
eBook - PDF- John E. Marthinsen(Author)
- 2020(Publication Date)
- De Gruyter(Publisher)
For instance, it is possible for government expenditures to encourage gross private domestic investment if it enlarges mar-kets, opens new business opportunities, and creates favorable expectations. The construction of a new highway may increase service investments along the road, such as gas stations and restaurants, and provide incentives for businesses to lo-cate near communities that can now be accessed more easily. Summary of the Fiscal Multiplier Figure 13.3 captures the effect that government borrowing-and-spending have on a nation ’ s real GDP and GDP Price Index. In the absence of any fiscal multi-plier, aggregate demand increases from AD 1 to AD 2 . The Fiscal Multiplier, with-out any weakening effects, increases aggregate demand from AD 2 to AD 3 , but once the weakening forces are considered, aggregate demand falls from AD 3 to AD 4 . The net result is an increase in aggregate demand from AD 1 to AD 4 . Government Surpluses Surpluses occur when governments spend less than they receive in tax reve-nues and fees. Commonly, surpluses are thought to be contractionary because Government Surpluses 377 falling government expenditures and rising taxes reduce aggregate demand. Therefore, when taxes exceed spending, the government is often viewed as tak-ing more away from aggregate demand than it contributes. As was the case with government budget deficits, economic forces in the three principal macroeconomic markets react to mitigate (but not completely offset) the contractionary impact of these surpluses. In the real goods and serv-ices market, as real GDP falls, tax revenues fall, government transfers rise, and imports fall. In the real credit market, the surplus increases the supply of real credit, thereby reducing the real interest rate and stimulating consumption and investment spending (see Figure 13.4).
eBook - ePubPublic Finance
An International Perspective
- Joshua E Greene(Author)
- 2011(Publication Date)
- WSPC(Publisher)
Chapter Two: How Fiscal Policy Affects the National Economy Government economic activity affects a nation’s economy, and viceversa. This chapter analyzes the impact of government economic policy, in particular fiscal policy, on the national economy. A variety of models and experience will be used to suggest how fiscal policy affects the rate of economic growth and inflation, the balance of payments, and the working of monetary policy. In addition, the chapter reviews how fiscal policy can be used for macroeconomic management, including ways for fiscal policy to promote economic growth. I. Fiscal Policy: An Introduction Fiscal policy represents the government’s efforts to shape economic activity through the government budget. Traditionally, fiscal policy has focused on the government’s budget balance — whether the budget is in surplus or deficit and by how much. However, fiscal policy encompasses much more than this. Fiscal policy also involves the size and composition of the government’s revenues ; the level and composition of government expenditures ; and the nature of budget financing, including the amount and composition of public debt. Each of these elements can affect an economy’s stability, including its rate of inflation and economic growth. In addition, assessing the stance of fiscal policy requires knowing the position not just of the central government, but of state or provincial and local governments as well, since they all collect revenues, make expenditures, and, in some cases, incur debt. It can also be useful to know about the financial position of state-owned (public) enterprises, since their profits help finance government expenditure and their outlays can burden government budgets and add to public debt
eBook - PDFEconomics
Theory and Practice
- Patrick J. Welch, Gerry F. Welch(Authors)
- 2016(Publication Date)
- Wiley(Publisher)
The multiplier effect also applies when nonincome‐determined expenditures are cut back. For example, a decrease in investment spending of $10,000,000, by the time it works its way through the economy, will cause the level of economic activity to decline by more than the initial $10,000,000 decrease. The multiplier effect is frequently used in local impact studies. Sometimes col- leges and universities, for example, will conduct economic studies and use a local multiplier to show how they bring positive economic benefits to a community. Students can be regarded as bringing injections into a local economy as they buy courses, hous- ing, food, books, and such. In addition, multipliers are used to justify large public projects like stadiums. The case is frequently made that a new stadium brings more fans into an area, becomes a tourist magnet, encourages spending for hotels and food, and thus creates additional employment and income for the area. In summary, changes in nonincome‐determined spending, such as investment spending, government and foreign purchases, and household expenditures from transfer payments or borrowing, will cause changes in economic activity that are a multiple of the initial change in spending. Application 5.3, “Ripples through the Economy,” provides three examples of the multiplier effect. The first deals with slumps experienced in western Pennsylvania because of coal and steel, the second with rewards from attracting conventions and sporting events to a city, and the third with recent problems in the auto industry. Keep in mind that the multiplier effect applies to both increases and decreases in spending. 7 Be careful when calculating the multiplier effect to always express the percentage of additional income not spent as a decimal. That is, if 20 percent of additional income is not spent, then the multiplier effect is determined by dividing the initial change in nonincome‐determined spending by 0.20, not by 20.
eBook - ePub- Alberto Alesina, Francesco Giavazzi, Alberto Alesina, Francesco Giavazzi(Authors)
- 2013(Publication Date)
- University of Chicago Press(Publisher)
2 Fiscal Multipliers in Recession and ExpansionAlan J. Auerbach and Yuriy Gorodnichenko*2.1 IntroductionA key issue coming out of recent economic events is the size of Fiscal Multipliers when the economy is in recession. In a recent paper (Auerbach and Gorodnichenko 2012), we extended the standard structural vector autoregression (SVAR) methodology in three ways to shed light on this issue. First, using regime-switching models, we estimated effects of fiscal policies that can vary over the business cycle, finding large differences in the size of spending multipliers in recessions and expansions with fiscal policy being considerably more effective in recessions than in expansions. Second, we estimated multipliers for more disaggregate spending variables that behave differently in relation to aggregate fiscal policy shocks, with military spending having the largest multiplier. Third, we showed that controlling for real-time predictions of fiscal variables tends to increase the size of the multipliers in recessions.In this chapter, we extend our previous analysis in three important ways. First, we estimate multipliers for a large number of Organization for Economic Cooperation and Development (OECD) countries, rather than just for the United States, again allowing for state dependence and controlling for information provided by predictions. Second, we adapt our previous methodology to use direct projections rather than the SVAR approach to estimate multipliers, to economize on degrees of freedom, and to relax the assumptions on impulse response functions imposed by the SVAR method. Third, we estimate responses not only of output but also of other macroeconomic aggregates. Our findings confirm those of our earlier paper. In particular, multipliers of government purchases are larger in a recession, and controlling for real-time predictions of government purchases tends to increase the estimated multipliers of government spending in recession.1
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