{"id":6041,"date":"2019-06-19T12:24:53","date_gmt":"2019-06-19T12:24:53","guid":{"rendered":"https:\/\/progressiveeconomyforum.com\/development\/?p=6041"},"modified":"2019-06-19T15:08:46","modified_gmt":"2019-06-19T15:08:46","slug":"austerity-and-the-fiscal-multiplier-double-or-quits","status":"publish","type":"post","link":"https:\/\/progressiveeconomyforum.com\/development\/blog\/austerity-and-the-fiscal-multiplier-double-or-quits\/","title":{"rendered":"Austerity and the fiscal multiplier – double or quits"},"content":{"rendered":"\n

Whilst shifts in fiscal\npolicy, as well as their timing, will influence the direction of real GDP\ngrowth, the degree of change will be significantly impacted by the size of the\nfiscal multiplier. This, of course, includes austerity policies. <\/p>\n\n\n\n

The fiscal multiplier\nis the ratio of the change in GDP, given a unit change in government spending.\nFor example, if the fiscal multiplier is 0.5 \u2013 as the IMF thought in 2010, when\nausterity was introduced in many countries \u2013 an increase in government spending\nof 1 percent of GDP should cause an increase in real GDP of 0.5 percent;\nconversely, a decrease<\/em> in spending of 1 percent of GDP (austerity) should\nproduce a 0.5 percent contraction<\/em>. <\/p>\n\n\n\n

In theory, at least,\nthe fiscal multiplier could also be negative, if, for example, a rising\ngovernment deficit causes a sharp reduction in confidence. In this case,\nausterity could cause GDP to increase. This was part of the rationale in\nsupport of the turn to austerity in 2010.<\/p>\n\n\n\n

However, if the\nmultiplier is higher than one, the change in GDP resulting from a 1 unit change\nin government spending will also be greater than 1. In other words, the smaller\nthe fiscal multiplier, the less austerity is likely to stress an economy. But a\nlarger multiplier will push an economy more sharply towards <\/em>recession \u2013 or deeper into it. <\/p>\n\n\n\n

In 2012, new IMF research<\/a> suggested that, from the start of the world recession in 2008, fiscal multipliers were actually much larger than 0.5 \u2013 and in the range of 0.9 to 1.7. This is a finding consistent with earlier research on fiscal multipliers in the aftermath of the 2008 crisis. <\/p>\n\n\n\n

If these figures are\ncorrect \u2013 and especially if the fiscal multiplier is well above 1 \u2013 austerity is\nnot only unlikely to reduce a government\u2019s fiscal deficit (and eventually\npublic debt); its effect on overall economic performance will be seriously\ndamaging. This is because, if, for example, the multiplier is 1.7, a reduction government\nspending of 1 percent of GDP will cause real GDP to fall by 1.7 percent.<\/p>\n\n\n\n

In short, if the fiscal\nmultiplier is positive but less<\/em> than\n1<\/em>, austerity will cause GDP to fall by less<\/em> than the reduction in\ngovernment spending; but, if it is positive and greater<\/em> than 1<\/em>, austerity will cause GDP to fall\nby more<\/em> than the public spending cut, thereby deepening the recession. <\/p>\n\n\n\n

However, despite the\nmultiplier\u2019s effect on the change in real GDP being relatively straight-forward\nto calculate \u2013 once you know what it is \u2013 arriving at an accurate estimate of\nthe current multiplier is very difficult; and forecasting it borders on the\nimpossible. <\/p>\n\n\n\n

The multiplier varies\nboth between countries and in different economic contexts. In a large country,\nsuch as the United States, for example, where an increase in government\nspending is likely to be met by domestic production, the multiplier will be\nrelatively large. By contrast, in smaller open economies, like the UK, it will\nbe much smaller. <\/p>\n\n\n\n

The state of the\neconomy is also a key determinant of a country\u2019s fiscal multiplier. If it is in\nrecession and unemployment is high, the multiplier will be larger, since any\nincrease in demand generated by government spending will be met with an\nincrease in supply \u2013 increasing employment to produce the goods and services\nrequired. By contrast, if an economy is at close to full employment, the fiscal\nmultiplier will be low, with any increase in government spending, likely to\ndisplace private sector spending.<\/p>\n\n\n\n

The type of fiscal policy will also be a factor. Government spending on newly produced, labour-intensive goods and services, or on transfer programs for the unemployed and economically disadvantaged, will encourage relatively high fiscal multipliers. This is because newly produced goods create jobs; and those newly employed people can be expected to spend most (if not all) of their earnings. Similarly, since those at the lower end of the distribution of income tend to spend a higher proportion of what they receive than the more affluent, the impact of fiscal policy supporting the more economically vulnerable, will have a stronger impact on GDP. <\/p>\n\n\n\n

By contrast, the fiscal\nmultiplier will be quite small for transfers and subsidies going to the better-off.\nThis is because recipients \u2013 already able to comfortably cover their outgoings \u2013\nare more likely to save, rather than spend, any extra income. <\/p>\n\n\n\n

To further complicate matters, the multiplier is also influenced by the policies of others, including the Central Bank and the governments of other countries. For example, when monetary policy is constrained by the zero lower bound on interest rates \u2013 as it has been since 2008 \u2013 and where numerous countries are pursuing austerity at the same time, the fiscal multiplier will be relatively high. <\/p>\n\n\n\n

The message, therefore, seems clear: If the success of your planned programme of austerity relies heavily on an accurate prediction of the fiscal multiplier, in the words of Clint Eastwood in Dirty Harry<\/em>: \u201cYou\u2019ve gotta ask yourself one question: \u2018Do I feel lucky?\u2019\u201d<\/p>\n\n\n\n

Photo credit: Flickr\/J D Mack<\/a><\/em>.<\/p>\n","protected":false},"excerpt":{"rendered":"

“Despite the multiplier\u2019s effect on the change in real GDP being relatively straight-forward to calculate \u2013 once you know what it is \u2013 arriving at an accurate estimate of the current multiplier is very difficult; and forecasting it borders on the impossible.”<\/p>\n","protected":false},"author":11,"featured_media":6045,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"nf_dc_page":"","_monsterinsights_skip_tracking":false,"_monsterinsights_sitenote_active":false,"_monsterinsights_sitenote_note":"","_monsterinsights_sitenote_category":0,"site-sidebar-layout":"default","site-content-layout":"default","ast-site-content-layout":"default","site-content-style":"default","site-sidebar-style":"default","ast-global-header-display":"","ast-banner-title-visibility":"","ast-main-header-display":"","ast-hfb-above-header-display":"","ast-hfb-below-header-display":"","ast-hfb-mobile-header-display":"","site-post-title":"","ast-breadcrumbs-content":"","ast-featured-img":"","footer-sml-layout":"","ast-disable-related-posts":"","theme-transparent-header-meta":"default","adv-header-id-meta":"","stick-header-meta":"","header-above-stick-meta":"","header-main-stick-meta":"","header-below-stick-meta":"","astra-migrate-meta-layouts":"default","ast-page-background-enabled":"default","ast-page-background-meta":{"desktop":{"background-color":"","background-image":"","background-repeat":"repeat","background-position":"center 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