Fiscal multipliers are zero with inflation targeting central banks

Here’s a VoxEU summary of a recent study by Ethan Ilzetzki, Enrique G. Mendoza and Carlos A. Vegh:

Data has long been the big hurdle to obtaining precise estimates of fiscal multipliers. In CEPR Policy Insight No. 39, we present our estimates of the fiscal multipliers for developed and emerging economies using new quarterly data for 45 countries (20 high-income and 25 developing) spanning 1960 through 2007.

I don’t like the way this is worded.  It sort of implies “the” multiplier is some sort of stable parameter out there, waited to be discovered.  Like the cosmological constant.  In fact, it is nothing more than an estimate of central bank incompetence, which will vary from one case to the next.

But I did like this:

As a second cut at the data, we divided our sample of 45 countries into those with predetermined exchange rates and those with more flexible exchange rate regimes.  Figure 3 shows the cumulative impulse responses, plainly illustrating the critical role played by the exchange rate regime.

*  Under predetermined exchange rates, the impact multiplier is 0.2 (and significantly different from zero) and rises all the way to 1.5 in the long-run.

*  Under flexible exchange rate regimes, however, the multiplier is indistinguishable from zero both on impact and in the long run.

Having flexible exchange rates is a necessary condition for inflation targeting.  And I liked this even more:

For the US, we find the impact multiplier is 0.64 and the long-run cumulative multiplier is 1.19. While these estimates are certainly closer to Romer’s than to Barro’s, they mask some important structural changes over the sample period. When estimating the multipliers for the pre-1980 period, we get considerably larger numbers than the post-1980 multipliers. The post-1980 multipliers are just 0.32 on impact and 0.4 in the long-run. This is certainly a far cry from the impact multiplier (1.05) and long-run multiplier (1.55) used in the Romer report.

After 1980 the Fed got much more competent at inflation targeting, and hence the fiscal multiplier fell much closer to zero.  Still, the Fed shouldn’t be satisfied until they get the multiplier all the way down to zero.

Tomorrow I promise a bunch of posts on the situation in the UK, for my British readers.


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10 Responses to “Fiscal multipliers are zero with inflation targeting central banks”

  1. Gravatar of Morgan Warstler Morgan Warstler
    6. July 2011 at 19:07

    I LOVE this argument. It is a stake in DeKrugman’s chest.

  2. Gravatar of Lorenzo from Oz Lorenzo from Oz
    6. July 2011 at 20:10

    It sort of implies “the” multiplier is some sort of stable parameter out there, waited to be discovered. Like the cosmological constant. In fact, it is nothing more than an estimate of central bank incompetence, which will vary from one case to the next. Great para!

  3. Gravatar of Steve Steve
    6. July 2011 at 20:59

    You usually criticize studies that find positive multipliers for “not controlling for monetary policy,” yet there’s no evidence that this study controlled for monetary policy either. In fact, there’s no discussion of the specifics of their methodology at all, other than the fact that they use a VAR, which is the same basic methodology that the studies you’ve criticized used. I guess since the results accord with your intuition, the methodology no longer matters?

  4. Gravatar of Morgan Warstler Morgan Warstler
    7. July 2011 at 04:50

    I think the meat is here:

    “After 1980 the Fed got much more competent at inflation targeting, and hence the fiscal multiplier fell much closer to zero. Still, the Fed shouldn’t be satisfied until they get the multiplier all the way down to zero.”

  5. Gravatar of marcus nunes marcus nunes
    7. July 2011 at 05:44

    It would still be zero if instead of IT the Fed pursued a target level of NGDP growth

  6. Gravatar of Scott Sumner Scott Sumner
    7. July 2011 at 06:42

    Thanks Morgan and Lorenzo.

    Steve, Good question. In the paragraph that Lorenzo quotes I argue that the multiplier should not be stable. Furthermore it should vary in predictable ways. They found that it did indeed vary in the ways I expected.

    I’ve never disputed the fact that some specific fiscal stimuli have “worked” in the sense of boosting NGDP. The military buildup of 1940-41 is one example.

    But your point is well taken. I’ve criticized the entire VAR approach, and now I am citing a study using that methodology. Again, my main point isn’t that the multiplier is always zero, but that it is contingent on the monetary regime. This study took that into account, whereas I think many other studies didn’t.

    But I agree that this study shouldn’t be viewed as definitive.

    Marcus, That’s right.

  7. Gravatar of Morgan Warstler Morgan Warstler
    7. July 2011 at 07:02

    There is no question that “some” government spending can have a multiplier over 1.

    There are situations that arise in the status quo where something needs done so much, that even if government does it, it will turn out in a positive way.

    However, this is a reflection that in the status quo, government has made such a muck of the private sector incentives – that no private party can step and solve for it.

    This is why I say there is SO MUCH low hanging fruit all around us, privatizing of government services – automating them into GOV2.0 – “there’s an app for that” thinking, can instantly pull us out of this recession….

    We only need a credible expectation that these changes are coming and the private sector money will TRIPLE DOWN on the US tech sector.

    Think about what happens if just the USPS is closed down:

    1. 9-12% of US commerce currently subsidized suddenly has to go online or start buying newspaper ads.

    2. ALL the elderly suddenly have BUY and LEARN to use a computer – which is totally possible with the new Chrome OS from Google. They cannot fuck it up.

    3. 100% of seniors must now use direct deposit of get a debit card – so we can shut down the SSA tele-service centers, we spend billions on so 17% of SS recipients can call and say “where is my check?”

    Another thought experiment: What happens if the Government stops backstopping any college loan that doesn’t result in a hard science of business degree?

  8. Gravatar of Scott Sumner Scott Sumner
    8. July 2011 at 17:22

    Morgan, Lots of good ideas–not much relevance to the fiscal multiplier.

  9. Gravatar of Jake Jake
    9. July 2011 at 10:47

    Not saying I disagree with you, but doesn’t the fact that it doesn’t distinguish weather the recessions in the studies were demand-side recessions mess the study up?

  10. Gravatar of Scott Sumner Scott Sumner
    10. July 2011 at 06:57

    Jake, Could be, I didn’t take a close look at the paper–just the summary. I’d hope they would have taken that distinction into account–they should have.

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