Fiscal multiplier/Tutorials

Measuring the Multiplier

Disagreements among economists about the size of the fiscal multiplier arise in part from the technical difficulties of estimating its magnitude under the conditions ruling at the time of a particular fiscal change. A partial escape from those difficulties can be achieved by referring to experience during comparable periods, but there have been numerous attempts to escape from the the data limitations of that approach.

One group of researchers use a regression analysis technique known as SVAR to determine the typical reaction of output to previously recorded fiscal changes. The problem about this method is that fiscal changes have often been taken in response to other things happening in the economy. Separating the impact of those other factors from the impact of fiscal change can be very difficult, and failure to do so successfully can result in omitted-variable bias resulting in an underestimate of the multiplier. According to Christine Romer, that has been a common cause of error.

Another approach involves the use of a development of general equilibrium models of the economy termed DSGE). Such models represent the equilibrium situation after the completion of the adjustments needed to bring supply into line in the product and labour markets. Multipliers estimated by their use are concerned with the ultimate effect of fiscal change rather than its short-term impact. The reliability of their estimates depend, in any case, upon the accuracy of the empirical and judgemental relationships embodied in the models.