In Search of The Fiscal Policy Multiplier

This article from the San Francisco Federal Reserve reviews recent research on the effect of government spending and tax policy on GDP. The focus was on determining the multiplier. That is, the effect of an additional dollar on output. During the debates on the use of fiscal policy in the Great Recession, conservatives estimated that the multiplier would be negative; others argued that the multiplier would be positive. Their estimates of the multiplier depended upon the assumptions that were made about the state of the economy, and on how the policy is implemented. That should not be surprising. Doctors do not prescribe the same medicine for every patient. They realize that each patient is unique, and that there are potentially damaging interactions between medications. The research on fiscal policy led to a similar conclusion. The economy is very complex and so is the manner in which fiscal policy is implemented. There is no such thing as a universal multiplier. In particular, it depends upon the relationship between fiscal policy and monetary policy. The multiplier is likely to be higher when monetary policy is limited by the zero bound. It also depends upon whether fiscal policy and monetary policy are working in the same direction. Given the result from this review of research on fiscal policy we can expect that economists and politicians will continue to view fiscal policy from the perspectives of their particular biases.