Fiscal Multipliers and Beyond

33 Pages Posted: 25 Sep 2015

Date Written: June 2015

Abstract

This paper seeks to link the debate surrounding short-term fiscal multipliers with the medium and longer-term impact of fiscal consolidation on public debt sustainability. A literature review and empirical findings for state-dependent multipliers confirm that there is considerable uncertainty surrounding the size of the short-term multiplier. Notably, multipliers may be larger in deep recessions or financial crises, but the negative impact of fiscal consolidation is mitigated when public finances are weak. Using a stylised framework and a range of plausible values for the fiscal multiplier, simulations suggest that an increase in the debt ratio following episodes of fiscal consolidation is likely to be short-lived. Even in a macroeconomic context in which multipliers are high, a frontloaded fiscal consolidation reduces the total consolidation effort and implies a faster stabilisation of the debt ratio. In general, backloading is subject to higher implementation risks, most notably in the light of political economy considerations. Overall, when determining the fiscal adjustment path, both the short-term costs and the longer-term benefits need to be taken into account. Particular attention should be paid to the composition of consolidation packages, with well-designed adjustments likely to imply a faster stabilisation of the debt ratio.

Keywords: fiscal policies, government debt, sustainability, macroeconomic aspects of public finance

JEL Classification: H30, H6, E6

Suggested Citation

Warmedinger, Thomas and Checherita-Westphal, Cristina D. and Hernández de Cos, Pablo, Fiscal Multipliers and Beyond (June 2015). ECB Occasional Paper 162, Available at SSRN: https://ssrn.com/abstract=2665597 or http://dx.doi.org/10.2139/ssrn.2665597

Thomas Warmedinger (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Cristina D. Checherita-Westphal

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Pablo Hernández de Cos

Banco de España ( email )

C/ Alcalá 48
Madrid, 28014
Spain

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