DP13648 Why Do Fiscal Multipliers Depend on Fiscal Positions?

Author(s): Raju Huidrom, Ayhan Kose, Jamus Lim, Franziska Ohnsorge
Publication Date: April 2019
Date Revised: April 2019
Keyword(s): Fiscal multipliers, fiscal position, interest rate, Ricardian channel, state-dependency
JEL(s): E62, H50, H60
Programme Areas: International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13648

The fiscal position can affect fiscal multipliers through two channels. Through the Ricardian channel, households reduce consumption in anticipation of future fiscal adjustments when fiscal stimulus is implemented from a weak fiscal position. Through the interest rate channel, fiscal stimulus from a weak fiscal position heightens investors' concerns about sovereign credit risk, raises economy-wide borrowing cost, and reduces private domestic demand. We document empirically the relevance of these two channels using an Interactive Panel Vector Auto Regression model. We find that fiscal multipliers tend to be smaller when fiscal positions are weak than strong.