Comparing Tax and Spending Multipliers: It's All About Controlling for Monetary Policy

Abstract:     
This paper derives empirical estimates for tax and spending multipliers. To deal with endogeneity concerns, I employ a large sample of fiscal consolidations identified through the narrative approach. To control for monetary policy, I study the output effects of fiscal consolidations in countries where monetary authorities are constrained in their ability to counteract shocks because they are in either a monetary union (and hence, lack an independent central bank) or a liquidity trap. My results suggest that for fiscal consolidations, the tax multiplier is larger than the spending multiplier. My estimates indicate that whereas the tax multiplier is roughly 3 — similar to the recent estimates derived by Romer and Romer (2010), the spending multiplier is close to zero. A number of caveats accompany these results, however.

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