Time-Varying Fiscal Spending Multipliers in the UK

Abstract

We study government spending multipliers of the UK economy using a time-varying parameter factor augmented vector autoregressive model (TVP-FAVAR) over the period 1966:Q1-2015:Q4. We show that government spending multipliers vary over time and that most of the variation is cyclical: multipliers for GDP are typically above one in recessions and below one in expansions. Regarding the drivers of the cyclical variation, our results are consistent with theories emphasizing the role of financial frictions and economic slack. We find no evidence that multipliers are larger at the zero lower bound. Structural factors seem to play a lesser role and multipliers do not exhibit a clear trend. We conclude that fiscal policy recommendations should take into account the position of the economy in the cycle in assessing their effectiveness and that the impact of government spending shocks is limited in the UK in non-recessionary periods.

Keywords: Government spending shocks, Fiscal transmission mechanism, Time-varying parameter models, Business cycle