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fiscal expansion multiplier economist issues

 Fiscal Expansion Multipliers Economists attempt to evaluate the overall impact of fiscal stimulus on the economy by estimating fiscal multi...




 Fiscal Expansion Multipliers Economists attempt to evaluate the overall impact of fiscal stimulus on the economy by estimating fiscal multipliers, which measure the ratio of a change in economic output to the change in government spending or revenue that causes the change in output. 14 A fiscal multiplier greater than one suggests that for each dollar the government spends or each dollar taxes are cut or transfers are increased, the economy grows by more than one dollar. A multiplier may be larger than one if the initial government stimulus results in further spending by private actors. For example, if the government increases spending on infrastructure projects as part of its stimulus, directly increasing aggregate demand, numerous contractors and construction workers will likely receive additional income as a consequence. 


If those workers then spend a portion of their new income within the economy, it further increases aggregate demand. Alternatively, a fiscal multiplier of less than one suggests that for each dollar the government spends, the economy grows by less than one dollar, suggesting the expansionary power of the fiscal stimulus is being partly offset by the contractionary pressures discussed above. Estimates of fiscal multipliers vary depending on the form of the fiscal stimulus and on which economic model the economist uses to measure the multiplier. 15 For example, a 2012 academic research article estimated fiscal multipliers for various forms of stimulus using several different prominent economic models from the Federal Reserve Board, the European Central Bank, the International Monetary Fund, the European Commission, the Organization for Economic Cooperation and Development, the Bank of Canada, and two models developed by academic 12 See, for example, Richard G. Anderson, “Inflation’s Economic Cost: How Large? How Certain?,” Federal Reserve Bank of St. Louis, July 2006, https://www.stlouisfed.org/publications/regional-economist/july-2006/inflationseconomic-cost-how-large-how-certain. 13 In August 2020, the Federal Reserve announced a change to its monetary policy strategy statement and that instead of targeting an inflation rate of 2%, it would target an average rate of 2%. For more information, see Board of Governors of the Federal Reserve System, “Guide to Changes in the Statement on Longer-Run Goals and Monetary Policy Strategy,” https://www.federalreserve.gov/monetarypolicy/guide-to-changes-in-statement-on-longer-run-goalsmonetary-policy-strategy.htm; and CRS Insight IN11499, The Federal Reserve’s Revised Monetary Policy Strategy Statement, by Marc Labonte. 14 Nicoletta Batini et al., Fiscal Multipliers: Size, Determinants, and Use in Macroeconomic Projections, International Monetary Fund, September 2014,


 https://www.imf.org/external/pubs/ft/tnm/2014/tnm1404.pdf. 15 For more information on different types of models used to estimate fiscal multipliers, see CRS Report R46460, Fiscal Policy and Recovery from the COVID-19 Recession, by Jane G. Gravelle and Donald J. Marples. Fiscal Policy: Economic Effects Congressional Research Service 5 economists. The authors found varying estimates (see Table 1) for different forms of fiscal stimulus ranging from 1.59 for cash transfers to low-income individuals to 0.23 for reduced labor income taxes.16 Based on these estimates, increasing government spending on consumption by 1% of GDP would result in a 1.55% increase in GDP, and decreasing labor income taxes by 1% of GDP would result in a 0.23% increase in GDP. Table 1. Average First-Year Fiscal Multipliers for Stimulus in Selected Models Fiscal Stimulus Multiplier Government Investment 1.59 Government Consumption 1.55 Targeted Transfers 1.30 Consumption Taxes 0.61 General Transfers 0.42 Corporate Income Taxes 0.24 Labor Income Taxes 0.23 Source: Gunter Coenen et al., “Effects of Fiscal Stimulus in Structural Models,


” American Economic Journal: Macroeconomics, vol. 4, no. 1 (January 2012), p. 46. Note: Multipliers are averages across the seven models of the first-year effects on real GDP of fiscal stimulus lasting for two years, assuming no change in monetary policy for two years. The magnitude of fiscal multipliers likely depends on where the economy is in the business cycle. As discussed above, during a recession fiscal stimulus is less likely to result in offsetting contractionary effects—such as rising interest rates, trade deficits, and inflation—resulting in a larger increase in economic activity from fiscal stimulus. Therefore, multipliers are expected to be smaller during expansions when stimulus is more likely to result in the crowding out of private consumption, investment, and net exports. Accordingly, many models estimate much larger multipliers during recessions than expansions. 17 Considerations Regarding Persistent Fiscal Stimulus Persistently applying fiscal stimulus can negatively affect the economy in the long term through three main avenues. First, persistent, large budget deficits can result in a rising debt-to-GDP ratio and lead to an unsustainable level of debt.18 Second, persistent fiscal stimulus—particularly during economic expansions—


can limit long-term economic growth by crowding out private investment. Third, rising public debt will require a growing portion of the federal budget to be directed toward interest payments on the debt, potentially crowding out other, more worthwhile sources of government spending. Some economic research has suggested that relatively high public debt negatively impacts economic growth. For example, one academic research paper suggested that for developed 16 Gunter Coenen et al., “Effects of Fiscal Stimulus in Structural Models,” American Economic Journal: Macroeconomics, vol. 4, no. 1 (January 2012), pp. 22-68. 17 Auerbach and Gorodnichenko, “Measuring the Output Responses to Fiscal Policy.” 18 Assuming annual budget deficits exceed the annual increase in GDP, the debt-to-GDP ratio will rise over time. Fiscal Policy: Economic Effects Congressional Research Service 6 countries, a 10 percentage point increase in the debt-to-GDP ratio is associated with a 0.15 to 0.20 percentage point decrease in per capita real GDP growth.

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