Blog Post

The multiplier myth

Many international economists have recently claimed that fiscal multipliers are much larger now than in normal times. The economic recession in Europe’s South, so the view, is primarily to be attributed to the fiscal consolidation undertaken that together with the larger multipliers has had devastating effects. Many good arguments speak in favor of this interpretation, including the fact that overall government spending in the four largest economies in the euro area has been growing below inflation in the last 3 years despite a weakening growth performance.

By: Date: February 22, 2013 Topic: European Macroeconomics & Governance

Many international economists have recently claimed that fiscal multipliers are much larger now than in normal times. The economic recession in Europe’s South, so is the view, is primarily to be attributed to the fiscal consolidation undertaken that together with the larger multipliers has had devastating effects. Many good arguments speak in favour of this interpretation, including the fact that overall government spending in the four largest economies in the euro area has been growing below inflation in the last 3 years despite a weakening growth performance.

Yet, I would dispute the simple view that fiscal consolidation was the main driver of weak growth. Let’s look at the specific case of Spain that nicely illustrates my point. First of all, Spain has not engaged in a fiscal austerity programme – contrary to what is often claimed. The table below taken from the just released winter forecast of the European Commission (http://ec.europa.eu/economy_finance/db_indicators/ameco/index_en.htm) shows that the budget deficit during 2010-12 actually did not come down at all. In 2012, Spain even enacted a slight economic stimulus with an increase in the deficit by 0.8 percentage points. Second, government expenditures increased by almost 7 bn euros. When excluding the effect of higher interest rates on government expenditure, government expenditure still slightly increased by around 2bn.  Also in structural terms, the budget deficit increased. Third, however, at the same time GDP growth collapsed falling by 1.8 percentage points to lead to a 1.4% contraction of GDP. 

2009

2010

2011

2012

2013

2014

budget balance

-11.2

-9.7

-9.4

-10.2

-6.7

-7.2

cyclically adjusted budget balance

-9.2

-7.4

-7.5

-8.0

-4.6

-6.1

GDP growth

-3.7

-0.3

0.4

-1.4

-1.4

0.8

Total expenditure

484.8

485.5

480.1

486.7

451.9

454.7

Applying a naïve multiplier analysis would thus suggest that the fiscal multiplier is not even zero but actually negative. This simple analysis suggests that different factors may have been responsible for the actual contraction of GDP. Perhaps the real reason for the deterioration in the economic situation in Europe was the massive drop in confidence of international investors in the ability of the euro area to overcome its more systemic problems. Perhaps there was also a more specific doubt about the ability of the Spanish government’s willingness to reduce its deficits to levels that would generally be seen as sustainability. Overall, the Spanish data thus put significant doubt on the naïve view expressed by some economists that excessive austerity is the main reason for the slowdown. Budget consolidation in Spain has certainly been moderate and deficit levels remain elevated. Instead, the breakdown in financial intermediation and the sharp increase in financing costs of the corporate sector may be the real evil.

Four conclusions follow. First and foremost, Europe needs to make progress on completing the banking union, resolving the problems in its banks and strengthening its institutional infrastructure. Second, monetary policy should be more aggressive in bringing down the financing costs and re-establishing the normal credit channel of monetary policy. Third, budget consolidations should continue in structural terms when fiscal deficits are clearly unsustainable – also in view of re-establishing confidence. Fourth, when tax revenues decline due to the decline in economic activity, one should not try to fill those holes – adding austerity to austerity would be the wrong choice.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.


Warning: Invalid argument supplied for foreach() in /home/bruegelo/public_html/wp-content/themes/bruegel/content.php on line 449
View comments
Read article More on this topic More by this author

Blog Post

Revision of the Posted Workers Directive misses the point

The Commission’s proposed revision of the Posted Workers Directive has been approved by the European Parliament’s Employment Committee, which welcomes the arrival of “equal pay for equal work”. But the revision will have little impact, and was largely unnecessary. Instead we should focus on the fight against bogus self-employment, social security fraud and undeclared work.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: October 18, 2017
Read article Download PDF More on this topic

Policy Contribution

Spotting excessive regional house price growth and what to do about it

Rapidly rising house prices are a well-known source of financial instability. This Policy Contribution examines whether there are regional differences in house price growth within European countries and, if so, whether this warrants more targeted measures to address vulnerabilities.

By: Grégory Claeys, Konstantinos Efstathiou and Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: October 18, 2017
Read about event More on this topic

Upcoming Event

Oct
26
14:30

Growth, productivity and social progress in Europe

On 26 October, Bruegel is organizing an interactive brainstorming seminar on Growth, Productivity and Social Progress in Europe. This is a closed-door, high-level workshop for a selected number of experts in the field.

Speakers: André Sapir Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Upcoming Event

Nov
6
12:30

An independent assessment of the EU's fiscal framework: presentation of the first annual report of the European Fiscal Board

This event will feature a presentation of the first Annual Report of the European Fiscal Board.

Speakers: Mateusz Szczurek, Niels Thygesen and Further speakers to be confirmed Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article

Blog Post

An update: sovereign bond holdings in the euro area – the impact of quantitative easing

Since the European Central Bank’s announcement in January 2015 of its quantitative easing programme, national central banks have been buying government and national agency bonds. In this post we look at the effect of QE on sectoral holdings of government bonds, updating calculations that we published initially in May 2016.

By: Pia Hüttl and David Pichler Topic: European Macroeconomics & Governance Date: October 10, 2017
Read article

Blog Post

India’s trade ties with the UK and EU

As EU and Indian leaders meet in Delhi, we look at the figures on trade. The UK’s place in the relationship warrants special attention. EU-India trade has more than tripled since 2000, but UK-India trade is largely static. The shift is especially noticeable for EU exports to India, where the UK share has dropped from 29% to 10%.

By: Maria Demertzis and Alexander Roth Topic: European Macroeconomics & Governance, Global Economics & Governance Date: October 6, 2017
Read article More on this topic More by this author

Blog Post

Catalonia and the Spanish banking system

As tensions rise around Catalonia's independence movement, there are worries about the impact on the Spanish banking sector. Banks based in Catalonia account for around 14% of total assets. Some major institutions are already moving their headquarters to other parts of Spain. However, most Spanish banks have significant exposure to the Catalan market, and all could be caught up in the turmoil.

By: Yana Myachenkova Topic: European Macroeconomics & Governance Date: October 6, 2017
Read article More on this topic

Blog Post

What has driven the votes for Germany’s right-wing Alternative für Deutschland?

The AfD vote in East Germany was consistently stronger than in the West, even after controlling for income, age, education, religion and the overall rural nature of the new Bundesländer.

By: Alexander Roth and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: October 5, 2017
Read about event

Upcoming Event

Nov
28
12:30

Sustainable growth in transition countries

This event will feature a presentation of the EBRD Transition Report 2017-18.

Speakers: Jonathan Charles, Zsolt Darvas, Jean Pisani-Ferry, Sergei Guriev and Debora Revoltella Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF

External Publication

European Parliament

The single monetary policy and its decentralised implementation: An assessment

This paper assesses the decentralised implementation of monetary policy by the Eurosystem in terms of its transparency, efficiency and simplicity. Compared to the Fed, the Eurosystem seems to have higher staff numbers and operational costs for similar tasks.

By: Francesco Papadia and Alexander Roth Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: October 4, 2017
Read article More on this topic More by this author

Blog Post

Ukraine’s oligarchs are bad for democracy and economic reform

Ukraine’s late and incomplete economic reform created a class of super-wealthy oligarchs who now stand in the way of further liberalisation. The oligarchs’ oversized influence only deepens public distrust in a structurally weak political system. Nevertheless, Ukraine is making some attempts to uproot corruption and the next steps are clear.

By: Marek Dabrowski Topic: European Macroeconomics & Governance Date: October 3, 2017
Read article Download PDF More by this author

External Publication

An innovation deficit behind Europe’s overall productivity slowdown?

Reinhilde Veugelers' chapter in "Investment and Growth in Advanced Economies", conference volume of the European Central Bank’s Forum on central banking in Sintra.

By: Reinhilde Veugelers Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: October 2, 2017
Load more posts