Larry Summers and I say, and said, and will say: THE FISCAL MULTIPLIER DEPENDS ON THE MONETARY POLICY REGIME. AT THE ZERO LOWER BOUND THE FISCAL MULTIPLIER WILL BE LARGE THAN IN A MONETARY POLICY REGIME OF SUBSTANTIAL OFFSET.
It’s (austerity) Multiplier Failure: The IMF’s forecasters are terribly worried about global growth – its new report not only contains further downward revisions to global growth forecasts, but talks of an alarming risk of a deeper slump, rising uncertainty, and so on…. Olivier Blanchard… notes that “activity has disappointed in a number of economies undertaking fiscal consolidation”. It then examines the key assumption — ie, the fiscal multipler — used for estimating the effect of fiscal consolidation (aka austerity, debt retrenchment etc) upon aggregate output (aka GDP): The main finding, based on data for 28 economies, is that the multipliers used in generating growth forecasts have been systematically too low since the start of the Great Recession, by 0.4 to 1.2, depending on the forecast source and the specifics of the estimation approach. Informal evidence suggests that the multipliers implicitly used to generate these forecasts are about 0.5. So actual multipliers may be higher, in the range of 0.9 to 1.7.
So… why did the IMF (among others) get it so wrong on the fiscal multiplier?
Antonio Fatás, an economics professor at INSEAD, has a theory…. [N]ew (and old) academic results have simply be displaced by the ideological debate that followed the fiscal policy stimulus of the 2008-2009 period, which somehow led to the conclusion that those policies did not work and that what we now needed was more austerity. And when over the last two years we forecasted GDP growth rates in the face of coordinated austerity by many governments we somehow forgot to consider that multipliers can be large….
The IMF special box on multiplier miscalculations notes that “earlier analysis by the IMF staff suggests that, on average, fiscal multipliers were near 0.5 in advanced economies during the three decades leading up to 2009″. That may be true too, but the uncertainty indicated by Blanchard’s own paper above suggests that assumptions about the multiplier are hardly safe.
The IMF says more work is warranted to examine the causes of this failure of multiplier assumptions. Perhaps monetary policy at the zero bound has some effect? Maybe it’s commodities prices? Who knows. But assumptions of a fiscal multiplier below 1 seem to be misplaced, at least right now…