Nonlinear fiscal multiplier controlling for policy and economic regimes

Abstract

A new form of the fiscal multiplier suited to data expressed as gross growth rates is proposed, together with a structural vector autoregression that isolates discretionary fiscal policy from regime and rule-based components. Because cumulating growth-rate responses over a horizon involves a product rather than a sum, the proposed multiplier is multiplicative: both numerator and denominator are polynomials in the size of the fiscal impulse, so the multiplier varies nonlinearly with the scale of the expenditure programme -- a dependence that conventional additive multipliers cannot capture. The multiplier requires no discounting, no ad hoc conversion factor, and no auxiliary estimate of an average expenditure share of output, and it is computed directly from nominal, non-seasonally-adjusted data, matching the terms in which government budgets are actually expressed. A version of the narrative approach to identification is introduced. It allows to decompose the influence of fiscal policy into a regime component, a standard policy rule embedded in the autoregressive structure, and discretionary shocks. Removing the regime component from the residuals yields smaller identified shocks, and correspondingly smaller multipliers, than found in SVARs not controlling for regime changes -- closing much of the gap between SVAR- and DSGE-based estimates. It is found that multipliers vary substantially across countries and across types of government expenditure, that regime volatility itself differs markedly by country, and that several economies display cyclicality in spending and multiplier paths that only becomes visible once responses are cumulated multiplicatively. The resulting multipliers are nominal, derived from unadjusted data, proven to be sensitive to shock size, and purged of regime effects, offering a tool with direct relevance for budget planning and fiscal policy evaluation.