Transportation funding in the EU: An instrumental variables approach to measure the fiscal multiplier

Jones, Jason (2015) Transportation funding in the EU: An instrumental variables approach to measure the fiscal multiplier. [Conference Proceedings] (Submitted)

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Abstract

Introduction: Understanding the size and nature of the fiscal multiplier (the effect government spending and/or taxing has on output) has taken on greater importance as governments have recently wrestled with the wisdom of conducting expansionary policy to combat recessions or contractionary policy to combat high debt levels. The renewed interest has led to a number of empirical advances in attempting to measure the size of the fiscal multiplier. Much of this literature has focused on the United States for two fundamental reasons. First, the government resorted to active fiscal policy in response to the financial crisis and resultant recession beginning in 2008. Second, the available empirical techniques used to measure the fiscal multiplier rely on data that are only readily available in the United States. The focus of these studies was to see how government spending and taxing policies could stimulate GDP in order to combat the recession in a manner such that it did not crowd out private investment. The results of numerous studies have yet to provide any conclusive answer to this question. More recent literature removes itself from the ideological argument about the actual value of the fiscal multiplier and focuses more on the circumstances that lead to a stronger multiplier as well as the fact that there is no one fiscal multiplier, but that it varies in size across countries and circumstances (Cimadomo, and Benassy-Quere, 2012). The need to more fully understand the fiscal multiplier in a European context has been heightened with the deficit crisis in Europe set off by the Greek admission of higher deficit and debt levels than previously reported in late 2009. The question for Europe, however, is not how to combat a recession with fiscal policy, but how austerity measures would or would not affect economic growth. As Europe fell into recession and continues to experience weak growth the question of the supposed effects of austerity led to sometimes comical (as in the well-publicized banter between Paul Krugman in the New York Times and the leaders of the Baltic States), as well as serious (Greece in particular) political upheaval. Yet the question is essentially the same as those posed in the literature for the United States, what is the size of the fiscal multiplier, regardless of whether or not you are increasing or decreasing deficits.

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