February 3rd, 2015
from the Congressional Budget Office
The Great Recession sparked wide interest in the economic effects of fiscal policy. That recent interest is reflected in an ongoing debate over the size of the fiscal multiplier [editor;s note: fiscal multiplier is the ratio of a change in national income to the change in government spending that causes it]. This article addresses three questions::
- What models do economists use to estimate that multiplier?
- Why do estimates of it vary widely?
- And how can economists use those estimates to judiciously analyze U.S. economic policy?
Three kinds of models are often used to generate estimates of the fiscal multiplier: macroeconometric forecasting models, time series models, and DSGE models. Each has strengths and limitations. For example, estimates generated by macroeconometric models benefit from being grounded in historical data and economic theory, but they also might be unreliable when policies or economic conditions differ substantially from the past.