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Fiscal multipliers in downturns and the effects of Eurozone consolidation

The literature on fiscal multipliers has expanded greatly since the outbreak of the Global Crisis. This column reports on a meta-regression analysis of fiscal multipliers collected from a broad set of empirical reduced form models. Multiplier estimates are significantly higher during economic downturns. Spending multipliers exceed tax multipliers, especially during recessions. The authors estimate that the Eurozone’s fiscal consolidation – most significantly transfer cuts – reduced GDP by 4.3% relative to the no-consolidation baseline in 2011, increasing to 7.7% in 2013.

The literature on the effect of fiscal shocks on macroeconomic performance has expanded a great deal since the outbreak of the Global Crisis. It is driven by new contributions that either question whether fiscal impulses are effective at all during economic downturns (Cogan et al. 2010), or ask whether their effectiveness increases in downturns relative to ‘normal’ circumstances (Auerbach and Gorodnichenko 2012). On our count, the number of contributions that estimate the effectiveness of fiscal policy increased from 56 in 2008 to 149 in 2013. A survey of this literature on how fiscal multipliers depend on the state of the economy and vary across different fiscal instruments would be of special value to policymakers, as it would help to evaluate the impact of fiscal austerity measures in the Eurozone on GDP, for example.

New meta-regression analysis of fiscal multipliers

However, the literature’s magnitude, and the fact that fiscal multiplier estimates can vary widely from one study to another, render a conventional survey a challenging task with a high probability of inconclusive – and hence unsatisfactory – results. In a new CEPR Policy Insight (Gechert et al. 2015), we therefore report on a meta-regression analysis of fiscal multipliers collected from a broad set of empirical reduced form models conducted by Gechert and Rannenberg (2014), by controlling for the economic regime associated with a given fiscal multiplier estimate. The aim was to identify and quantify their dependence on the economic circumstances of the period in which the multiplier was estimated. This is done for a range of different fiscal policy instruments, controlling for model and sample uncertainties.

Our meta-analysis finds that the fiscal multiplier estimates are significantly higher during economic downturns than in average economic circumstances or in boom periods. For example, the multiplier of nonspecific government expenditures on goods and services rises by an average of 0.6 to 0.8 points during a downturn. But for some specific instruments – fiscal transfers, for example – the multiplier increases by much more, turning transfers from the second least effective expenditure instrument to the most effective one. By contrast, Gechert and Rannenberg (2014) do not find any regime dependence in the impacts of tax changes. In fact, the spending multipliers uniformly exceed tax multipliers by about 0.3 units in normal times, and more so in recession periods. Furthermore, during normal times and in boom periods, fiscal multipliers tend to vary less across different fiscal instruments. This set of results is consistent with the presence of active monetary policies during such periods, which neutralise the effect of demand shocks, but a more accommodating monetary policy during downturns (Woodford 2011).

Given these results, we can investigate which instruments have cumulative multipliers that exceed one during economic downturns by taking averages across estimation techniques and specific characteristics. Gechert and Rannenberg (2014) find that, for all expenditure categories other than increases in nonspecific government spending, the cumulative multipliers always exceed one in a downturn (Figure 1).

Figure 1. Compound cumulative multipliers of fiscal impulses for different regimes (full sample)

Note: Upper: above average economic circumstances; Average: average economic circumstances; Lower: below average economic circumstances.

Implications for fiscal consolidation in Europe

What does this mean for the effectiveness of austerity and debt reduction policies in Europe? Table 1 presents the cumulative ex-ante budget balance effect calculated from these estimates. The table says that, in 2011, for example, discretionary consumption tax changes amounted to 0.3% of GDP. Further changes in 2012 and 2013 raised the total increase to 0.9% of GDP over the period 2011–2013. Similarly, transfers were cut by 1% of GDP in 2011 and by a total of 1.5% of GDP over the full 2011–2013 period.

Table 1. Consolidation actions in the Eurozone: Cumulative discretionary measures (% of GDP)

Source: European Commission (2012), own calculations.

Applying the cumulative multipliers from our meta-study to estimates of the cumulative changes of the individual fiscal instruments by the European Commission (2012), the Eurozone’s fiscal consolidation reduced GDP by 4.3% relative to the no-consolidation baseline in 2011, increasing to 7.7% in 2013 (Table 2). Thus austerity came at considerable cost. By far the biggest contributor to this GDP decline comes from transfer cuts, which is not surprising given their high multiplier and high share in the overall consolidation effort.

Table 2. Estimated cumulative GDP and deficit effect of the Eurozone’s fiscal consolidation (% of GDP)

The ultimate goal of the Eurozone’s fiscal consolidation is to achieve fiscal sustainability. To gauge the consolidation’s effect on the budget balance, we apply an estimate of the semi-elasticity of the budget balance with respect to GDP to the estimated GDP decline caused by the fiscal consolidation, and then subtract this number from the discretionary consolidation effort. Girouard and Andre (2005) estimate the semi-elasticity of the budget balance as 0.48. Due to the big decline in GDP caused by fiscal consolidation, the improvement in the budget balance we estimate is marginal compared to the GDP loss caused by consolidation.


Auerbach, A J and Y Gorodnichenko (2012), “Measuring the Output Responses to Fiscal Policy”, American Economic Journal: Economic Policy 4(2): 1–27.

Cogan, J F, T Cwik, J B Taylor, and V Wieland (2010), “New Keynesian versus Old Keynesian Government Spending Multipliers”, Journal of Economic Dynamics and Control 34(3): 281–295.

European Commission (2012), European Economic Forecast, Spring 2012.

Gechert, S and A Rannenberg (2014), “Are Fiscal Multipliers Regime-Dependent? A Meta Regression Analysis”, IMK Working Paper 139.

Gechert, S, A Hughes Hallett, and A Rannenberg (2015), “Fiscal multipliers in downturns and the Effects of Eurozone Consolidation”, CEPR Policy Insight 79.

Girouard, N and C André (2005), “Measuring cyclically adjusted budget balances for OECD Economies”, OECD Economics Department Working Paper 434.

Woodford, M (2011), “Simple Analytics of the Government Expenditure Multiplier”, American Economic Journal: Macroeconomics 3(1): 1–35.

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