Blanchard and Leigh’s IMF working paper “Growth Forecast Errors and Fiscal Multipliers” (Blanchard and Leigh 2013a, 2013b) and its preceding Box in the IMF World Economic Outlook (IMF 2012) have been widely discussed, and have clearly influenced the policy debate and possibly the policy stance in some countries. For many, the work of Blanchard and Leigh presents convincing evidence that during the Crisis multipliers were larger than expected (e.g. Krugman 2012, Davies 2012, Fatás and Summers 2015). Their results support other research indicating larger multipliers when the output gap is strongly negative (e.g. Auerbach and Gorodnichenko 2012, 2013, Baum et al. 2012). However, research from the OECD (OECD 2014, Lewis and Pain 2015) suggests this result depends on the inclusion of Greece in the sample and that a more important explanation for the forecast errors is the assumption that the Eurozone Crisis would dissipate and sovereign bond yields would narrow.
The forecasts by Blanchard and Leigh are made using information available early in a given year. If countries which were expected to improve their structural fiscal balance performed worse than expected, then fiscal multipliers would be underestimated in the forecasts.1
The update and extension
We have extended their estimates up to 2015 and updated their estimates on the basis of more recent actual data on economic growth (the IMF World Economic Outlook of October 2015). We use their selection of 28 countries (EU27, excluding Estonia and Latvia, including Iceland, Norway, and Switzerland).
Figure 1. Economic growth and the output gap, Eurozone, 2007-2015
Source: IMF World Economic Outlook October 2015.
Table 1. Estimated β-coefficient
Note: Table 1 reports point estimates and Newey-West standard errors in parentheses (corrected for heteroskedasticity and autocorrelation up to one year). Statistical significance levels of 1%, 5% and 10% are indicated by ***, ** and *, respectively. Due to data availability Lithuania and Luxembourg were not included in 2009-2010, 2010-2011, 2011-2012; Romania was not included in 2011-2012; Cyprus was not included in 2013-2014, 2014-2015.
Table 1 shows our estimation results and the results of Blanchard and Leigh. (We were able to reproduce Blanchard and Leigh’s estimations using the October 2012 data.) While actual economic growth, used to calculate the forecast error, in Blanchard and Leigh is based on the World Economic Outlook database of October 2012, we use the October 2015 version of this database. As Blanchard and Leigh did, we find a negative and statistically significant coefficient for 2009-2010 and 2010-2011 but not for 2011-2012. Our estimated coefficient for the period 2010-2011 is even larger than the original estimate (although the difference is not statistically significant). For 2012-2013 we find a larger estimate than Blanchard and Leigh, but due to the higher standard error the estimated coefficient is no longer significant at the 5% level. For this period, Blanchard and Leigh’s estimate was rather premature as the predictions in October 2012 were applied as outcomes. In the two periods we added, our estimated coefficients are close to zero. No negative coefficient for recent years could be seen as consistent with the end of the Crisis as indicated by the pick-up in economic growth, although the output gap has remained sizeable (see Figure 1). However, it could also indicate learning by IMF forecasters. As Blanchard and Leigh did, we find a statistically significant negative coefficient in the panel forecast for 2009-2013. This result holds for the prolonged period 2009-2015. However, we do not find a statistically significant coefficient when we perform the panel analysis for the period 2011-2015.
The policy relevance of this result is that on the basis of the Blanchard-Leigh approach, there is no evidence that during the recent crises fiscal multipliers were higher than expected. There are indications this is true for the credit crisis (2009) but the evidence is less convincing for the sovereign debt crisis (2012-2013). While the drop in output in the Eurozone was smaller during the sovereign debt crisis, the output gap was almost as severe as in 2009 (see Figure 1). These results indicate that using the Blanchard-Leigh approach, there is no evidence that multipliers are currently higher than before the Crisis, assuming a similar monetary policy reaction function.
Auerbach, A and Y Gorodnichenko (2012), “Measuring the Output Responses to Fiscal Policy”, American Economic Journal: Economic Policy, vol. 4(2), pp. 1-27.
Auerbach, A and Y Gorodnichenko (2013), “Fiscal Multipliers in Recession and Expansion”, in: Alesina, A. and F. Giavazzi (eds.), Fiscal Policy after the Financial Crisis, University of Chicago Press.
Baum, A, M Poplawski-Ribeiro and A Weber (2012), “Fiscal Multipliers and the State of the Economy“, IMF Working Paper 12/286.
Blanchard, O and D Leigh (2013a), “Growth Forecast Errors and Fiscal Multipliers”, IMF Working Paper 13/1.
Blanchard, O and D Leigh (2013b), “Growth Forecast Errors and Fiscal Multipliers”, American Economic Review: Papers and Proceedings, vol. 103(3), pp. 117-120.
Davies, G (2012), “High Fiscal Multipliers Undermine Austerity Programmes”, Financial Times blog.
Fatás, A and L H Summers (2015), “The Permanent Effects of Fiscal Consolidations”, CEPR Discussion Paper 10902.
IMF (2012), “Are We Underestimating Short-term Fiscal Multipliers?”, Box 1.1 in World Economic Outlook, October.
Krugman, P (2012), “The IMF and the GOP”, New York Times blog.
Möhlmann, J and W Suyker (2015), “An Update of Blanchard’s and Leigh’s Estimates in Growth Forecast Errors and Fiscal Multipliers”, CPB Background Document.
Lewis, C and N Pain (2015), “Lessons from OECD forecasting during and after the financial crisis”, OECD Journal: Economic Studies, 2014(1):9.39.
OECD (2014), “OECD forecasts during and after the financial crisis: A Post Mortem”, OECD Economics Department Policy Notes No. 23.
1 The equation estimated by Blanchard and Leigh and by us is:
Forecast error of ΔYi,t:t+1 = a = β Forecast of ΔFi,t:t+1|t + ɛi,t:t+1,
where ΔY represents the cumulative change in real GDP in country i and ΔF represents the change in the general government structural fiscal balance in percent of potential GDP. A negative sign for β indicates that countries which were expected to improve their structural fiscal balance performed worse than expected by the forecasts.