The IMF (2010) “Will It Hurt?” (Chapter 3 of WEO; Daniel Leigh, Pete Devries, Charles Freedman, Jaime Guajardo, Douglas Laxton, and Andrea Pescatori) concludes that the multiplier at the zero nominal lower bound is more than twice the size of the normal-time multiplier. Moreover, it concludes that the hope that fiscal contractions could be expansionary--even away from the zero lower bound, where monetary accommodation is a real possibility--was for the most part nothing but a mirage:
[W]hen the only two episodes of fiscal consolidation considered are those of Denmark (1983) and Ireland (1987), the estimated effect on output is indeed positive.... These findings are consistent with the finding of Giavazzi and Pagano (1990) that Denmark and Ireland experienced ‘expansionary fiscal contractions’. However, the results also suggest that these two cases are not representative of the normal output response, even among countries with a relatively poor initial credit rating...
The costs of fiscal contraction/benefits of fiscal stimulus appear to be lowest when (a) the country faces substantial perceived sovereign risk already, (b) central banks respond by shifting monetary policy to offset the effects of fiscal policy, and (c) the policy mix is spending-heavy—perhaps because central banks are more willing to offset spending shifts which have no immediate impact on inflation than tax changes that do…
