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Authors: Olivier J. Blanchard Daniel Leigh Working Paper 18779 http://www.nber.org/papers/w18779

Wednesday 13 February 2013, by Carlos San Juan

This paper investigates the relation between growth forecast errors and planned fiscal consolidation during the crisis. We find that, in advanced economies, stronger planned fiscal consolidation has been associated with lower growth than expected, with the relation being particularly strong, both statistically and economically, early in the crisis. A natural interpretation is that fiscal multipliers were substantially higher than implicitly assumed by forecasters. The weaker relation in more recent years may reflect in part learning by forecasters and in part smaller multipliers than in the early years of the crisis.


What do our results imply about actual multipliers? Our results suggest that actual fiscal multipliers have been larger than forecasters assumed. But what did forecasters assume? Answering this question is not easy, since forecasters use models in which fiscal multipliers are implicit and depend on the composition of the fiscal adjustment and other economic conditions.36

We believe, however, that a reasonable case can be made that the multipliers used at the start of the crisis averaged about 0.5. A number of studies based on precrisis data for advanced economies indicate actual multipliers of roughly 0.5, and it is plausible that forecasters, on average, made assumptions consistent with this evidence. The October 2008 WEO chapter on fiscal policy presents multiplier estimates for 21 advanced economies during 1970–2007 averaging 0.5 within three years (IMF, 2008, p. 177). Similarly, the October 2010 WEO (IMF, 2010d) chapter on fiscal consolidation presents multiplier estimates for 15 advanced economies during 1979–2009 averaging 0.5 percent within two years.37 This evidence, and our finding of no gap, on average, between assumed and actual fiscal multipliers before the crisis, would imply that multipliers assumed prior to the crisis were around 0.5. Relatedly, the March 2009 IMF staff note prepared for the G-20 Ministerial Meeting reports IMF staff assumptions regarding fiscal multipliers based on estimates from various studies. In particular, it contains an assessment of the impact of the 2008–10 fiscal expansion on growth based on assumed multipliers of 0.3–0.5 for revenue and 0.3–1.8 for government spending (IMF, 2009b, p. 32).38

If we put this together, and use the range of coefficients reported in our tables, this suggests that actual multipliers were substantially above 1 early in the crisis. The smaller coefficient we find for forecasts made in 2011 and 2012 could reflect smaller actual multipliers or partial learning by forecasters regarding the effects of fiscal policy. A decline in actual multipliers, despite the still-constraining zero lower bound, could reflect an easing of credit constraints faced by firms and households, and less economic slack in a number of economies relative to 2009–10.

However, our results need to be interpreted with care. As suggested by both theoretical considerations and the evidence in this and other empirical papers, there is no single multiplier for all times and all countries. Multipliers can be higher or lower across time and across economies. In some cases, confidence effects may partly offset direct effects. As economies recover, and economies exit the liquidity trap, multipliers are likely to return to their precrisis levels. Nevertheless, it seems safe for the time being, when thinking about fiscal consolidation, to assume higher multipliers than before the crisis. Finally, it is worth emphasizing that deciding on the appropriate stance of fiscal policy requires much more than an assessment regarding the size of short-term fiscal multipliers. Thus, our results should not be construed as arguing for any specific fiscal policy stance in any specific country. In particular, the results do not imply that fiscal consolidation is undesirable. Virtually all advanced economies face the challenge of fiscal adjustment in response to elevated government debt levels and future pressures on public finances from demographic change. The short-term effects of fiscal policy on economic activity are only one of the many factors that need to be considered in determining the appropriate pace of fiscal consolidation for any single country.

Attached documents

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    GROWTH FORECAST ERRORS AND FISCAL MULTIPLIERS Olivier J. Blanchard Daniel Leigh Working Paper 18779

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