Decomposing the Fiscal Multiplier

Abstract

Unusual circumstances often coincide with unusual fiscal policy actions. Much attention has been paid to estimates of how fiscal policy affects the macroeconomy, but these are typically average treatment effects. In practice, the fiscal "multiplier" at any point in time depends on the monetary policy response. Using the IMF fiscal consolidations dataset for identification and a new decomposition-based approach, we show how to evaluate these monetary-fiscal effects. In the data, the fiscal multiplier varies considerably with monetary policy: it can be zero, or as large as 2 depending on the monetary offset. We show how to decompose the typical macro impulse response function into (1) the direct effect of the intervention on the outcome; (2) the indirect effect due to changes in how other covariates affect the outcome when there is an intervention; and (3) a composition effect due to differences in covariates between treated and control subpopulations. This Blinder-Oaxaca-type decomposition provides convenient way to evaluate the effects of policy, state-dependence, and balance conditions for identification.

Action-Based Fiscal Consolidations and Economic Growth

“…The IMF dataset on fiscal consolidations has been widely used in the literature to estimate the effects of fiscal consolidations on GDP growth, either as the main variable (e.g., Guajardo et al 2014;Jordà and Taylor 2016;Cloyne et al 2020;Carrière-Swallow et al 2021), as a robustness check (Pappa et al 2015), or to construct fiscal plans (Alesina et al 2015(Alesina et al , 2018(Alesina et al , 2019a(Alesina et al , 2019b. In all those papers, the identifying assumption was that contemporaneous GDP growth has no effect on action-based fiscal consolidations.…”