Annual EBHS Conference, 39th Annual Economic and Business History Society Conference

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Fiscal Multipliers in Times of Crisis and Prosperity: Historical Evidence from Greece
Tadeusz Gwiazdowski, George Chouliarakis, Sophia Lazaretou

Last modified: 2014-03-10


The goal of this paper is to investigate empirically whether the sign and size of fiscal multipliers varies with the state of the economy and the policy regime under which an economy operates. In so doing, the paper aims to contribute to the ongoing debate about the effectiveness and scope of discretionary fiscal policy in face of adverse shocks and when interest rates are at the zero lower bound.

Motivation and Method:
The effectiveness and scope of discretionary fiscal policy has been a highly contentious issue since the onset of the recent financial crisis. But, with a few notable exceptions, the debate has so far neglected the potentially critical importance of the business cycle and the exchange rate regime on the effectiveness of discretionary fiscal policy in the near term. We seek to extend the existing literature, and fill this gap, by studying the effect that the state of the economy and the exchange rate regime has on the sign and size of the fiscal multiplier. We do so with the aid of history, i.e., by exploiting the wealth of information contained in several business cycles and numerous exchange rate regime changes that the Greek economy – a typical peripheral European economy – experienced during its turbulent 19th and early 20th century history.
In terms of methodology, we extend the work of Hall (Brooking Papers on Economic Activity, 2009) and Barro and Redlick (Quarterly Journal of Economics, 2011) by using a threshold autoregressive model in order to allow for state-dependent estimates of fiscal multipliers. We also identify exogenous fiscal policy shocks – the key to sound fiscal multiplier estimates – by using a newly constructed series on military expenditure as an instrument for government spending (see Almunia et al (Economic Policy, 2010), Romer and Romer (American Economic Review, 2010) and Ramey (Quarterly Journal of Economics, 2011)).

Our key finding is that, during recessions and under a currency peg, there is a positive, significant and potentially large government spending multiplier. However, government spending multipliers in floating exchange rate regimes are found to be relatively small with a mild but statistically insignificant increase during recessions. Finally, in times of prosperity, government spending multipliers are found to be small suggesting a significant crowding out of private spending. Overall, fiscal multiplier estimates that disregard the state of the economy or the policy regime within which an economy operates may lead to misleading policy prescriptions and should be treated with scepticism.