Decomposing the Fiscal Multiplier
53 Pages Posted: 6 Apr 2020 Last revised: 9 Feb 2023
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Decomposing the Fiscal Multiplier
Decomposing the Fiscal Multiplier
Date Written: April 2020
Abstract
The fiscal “multiplier” seeks to measure how many additional dollars of output are gained or lost for each dollar of fiscal expansion or contraction. In practice, the multiplier at any point in time depends on the monetary policy response and existing conditions in the economy. Using the IMF fiscal consolidations dataset for identification and a new decomposition-based approach, we show how to quantify the importance of these monetary-fiscal interactions. In the data, the fiscal multiplier varies considerably with monetary policy: it can be as small as zero, or as large as 2, depending on the monetary offset. More generally, we show how to decompose the typical macro impulse response function by extending local projections to carry out the well-known Kitagawa-Blinder-Oaxaca decomposition. This provides a convenient way to evaluate the effects of policy, state-dependence, time-variation, and the balance conditions for identification.
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