Multipliers and New Zealand

In an interesting piece on Vox, Ethan Ilzetzki, Enrique G. Mendoza, and Carlos A. Vegh discuss their estimates of fiscal multipliers, and some of the reasons they differ between countries.  As multipliers are often used to justify the government spending during a recession, it would be useful to note down how their results related to a small open economy like New Zealand.

Summarising their findings they state:

Here is a brief summary of the highlights:

• The response of output to increases in government spending is smaller on impact and considerably less persistent in developing countries than in high-income countries.
• Fiscal multipliers are much larger in economies operating under predetermined exchange rate regimes than under flexible exchange rates.
• Relatively closed economies have much larger multipliers than relatively open economies.
• The output response to increases in government spending is short-lived and much less persistent in highly indebted countries than in countries with a low debt to GDP ratio.
• The multipliers for the US in the post-1980 period are small both in the short and long-run. On the other hand, multipliers for government investment are large.

The first four points are relevant to New Zealand.  We are a high income country, so on this dimension multipliers are stronger.  We have a floating exchange rate and are a highly open economy, along these dimensions the multiplier will be lower.  Furthermore, our debt to GDP ratio is high – so that also implies that the multiplier will be lower.

Now I’m not a fan of multiplier analysis per see.  While I agree that additional government spending can lead to a higher level of economic output in some circumstances, I prefer to try and understand those specific circumstances instead of running round with a multiplier co-efficient.

This is partially what this work does.  It has taken some of the elements that can be expected to influence a “multiplier estimate” and found how they do influence it empirically.  Furthermore, these estimates seem to imply that any such multiplier will be quite small for the New Zealand economy:  as we have an open economy, a floating exchange rate, and high debt levels.

What does this tell me.  Well, it seems to reinforce my belief that any government spending in NZ justified on the basis of an arbitrary multiplier is suspect, and so anyone trying to sell me these types of policies is not to be trusted 😉