During the recovery from the 2008-2009 financial crisis, an international call was made for the coordination of fiscal stimulus (e.g. G20 2008). The argument then was that countries needed to act together in order to get the maximum benefit from their respective spending programmes. Now countries are moving in reverse. The dominant stance is that of withdrawal of fiscal stimulus or consolidation. The question then arises as to whether such coordinated consolidation will have significant growth spillover effects. And can Germany, which has so far escaped market pressures, slow down its consolidation path to mitigate the negative spillovers from global consolidation, especially to the peripheral European economies?
Under normal circumstances, when fiscal policies and business cycles are unsynchronised, a change in the fiscal stance of a single country has limited global impact. Recent IMF spillover reports (IMF 2011a and 2011b) find that the projected fiscal consolidation in the US and the Eurozone alone will have limited global demand effects. However, the synchronisation of the consolidation has the potential to generate larger effects.
In a recent paper (Ivanova and Weber 2011), we use a simple and transparent analytical framework to simulate domestic and international growth spillover effects from fiscal consolidation in 2011 and 2012, based on fiscal projections for 20 economies covering more than 70% of world GDP. The sample includes major Eurozone countries as well as other large countries.1 The framework assesses spillovers through trade channels employing empirical estimates of fiscal multipliers and import elasticities obtained in other studies.2 The approach accounts for carry-over effects from the previous years’ fiscal positions while differentiating between revenue and expenditure measures. Thus, it quantifies the direct demand impact of consolidation but does not capture the more nebulous credibility effects, which would mitigate the negative demand spillovers.
Figure 1. Germany: Growth contribution of domestic fisal changes and spillover from fiscal changes in other countries, 2010-2012
Under relatively generous baseline multiplier assumptions, fiscal changes envisaged in 2011 and 2012 can be expected to reduce the GDP growth cumulatively by about 1¼ percentage points.3 The domestic effects of consolidation will dominate, contributing 80% of the growth contraction, with spillovers from one country to another contributing the remaining 20%. There is, however, a large variation across countries. The domestic effect from fiscal consolidation will be substantial in Greece, Spain, Portugal, and the UK, exceeding 2 percentage points over the 2 years. The domestic impact of fiscal consolidation on growth in Sweden, Switzerland, and Brazil can be expected to be rather small, less than half a percentage point. The German domestic drag on growth from its fiscal consolidation over these 2 years will be noticeable—expected to reach 1 percentage point with another quarter of a percentage point subtracted from growth due to the spillovers from abroad.
Figure 2. Inward fiscal spillovers (impact on real GDP from fiscal changes in other countries after 2 years, in %)
For most countries, spillovers to growth from fiscal policy in other countries are limited (below half a percentage point over the next 2 years), but Ireland, Belgium, Austria, and the Netherlands are more substantially affected (see Figure 2). Ireland, in particular, could substantially benefit from a coordinated fiscal relaxation, although this would require contributions from the major economies, including the US and the UK—both countries where such relaxation is not on the cards.
Figure 3. Impulse response of the output level in each country after 2 years to a government spending shock in Germany, France, and the US
German fiscal policy alone, in contrast, has limited consequences for European growth, especially for the peripheral countries in the Eurozone with which Germany has weak trade links.4 Under the baseline multipliers, the growth impact of the projected German fiscal path on other countries does not exceed one quarter of a percentage point over the 2 years with the impact on the European peripheral countries not exceeding 0.1 percentage points (see Figure 3). Even under very high multipliers,5 a 1% of GDP fiscal expenditure stimulus in Germany would raise the GDP growth in Ireland by only 0.3 percentage points after 2 years, in Portugal by 0.1 percentage points, and have virtually no effect on growth in Greece.6 Similarly, fiscal policy changes in Germany alone have only a small impact on the trade balance of the peripheral countries, and are thus unlikely to contribute to the reduction in peripheral countries’ imbalances.7
The bad news is that countries in need cannot rely much on other countries’ fiscal policies to stimulate their growth in the short run. The good news, however, is that ambitious domestic fiscal consolidation plans in the countries that need to restore fiscal sustainability will have limited repercussions for much of the rest of the world.
The views expressed in this article are those of the author and do not necessarily represent those of the IMF, IMF policy, or the Executive Board of Directors.
This and companion columns on growth spillovers and structural contributors to the current-account surplus form background work for the IMF’s 2011 Article IV Consultation with Germany, which was concluded on 6 July 2011. The staff report is available here.
Beetsma, R, M Giuliodori and F Klaassen (2006), "Trade Spillovers of Fiscal Policy in the European Union: A Panel Analysis", Economic Policy, CEPR, CES, MSH, 21(48):639-687.
Cwik, T and V Wieland (2009), "Keynesian Government Spending Multipliers and Spillovers in the Euro Area", CEPR Discussion Papers 7389.
G20 (2008), “Declaration of the summit on financial markets and the world economy”, 15 November.
IMF (2011a), “Euro Area Policies: Spillover Report for the 2011 Article IV Consultation and Selected Issues”, IMF Country Report 11/185.
IMF (2011b), “The US Spillover Report – 2011 Article IV Consultation”, IMF Country Report 11/203.
Ivanova, A and Sebastian Weber (2011), “Do Fiscal Spillovers Matter?”, IMF Working Paper (forthcoming).
OECD (2009), “The Effectiveness and Scope of Fiscal Stimulus”, OECD Economic Outlook Interim Report, March.
1 The full list of countries includes Austria, Belgium, Brazil, France, Germany, Greece, Ireland, Italy, India, Netherlands, Portugal, Spain, Korea, Russia, Sweden, Switzerland, China, Japan, United Kingdom and United States.
2 We largely rely on a baseline set of multipliers reported in OECD (2009) with modifications for several countries based on other studies. We also employ a range of multipliers and imports elasticities for robustness checks.
3 The average baseline multiplier across the sample of 20 countries is 0.5 for revenue and 0.8 for expenditure after two years. Hence, the baseline multipliers are relatively high.
4 Beetsma et al. (2006), Cwik and Wieland (2009) also suggest small spillover effects from Germany to other European countries.
5 High multipliers were computed as baseline multipliers plus 4 times standard deviation of the multipliers in the sample of 20 countries. This results in an average expenditure multiplier of 1.6 after two years.
6 In principle, higher multipliers could be caused by a higher propensity to consume or a lower propensity to import. Our simulations are based on the assumption that the propensity to consume is higher and the propensity to import is unchanged. A lower propensity to import would lead to lower spillovers. Thus, our alternative scenario provides an upper bound estimate.
7 The effect of German fiscal policy on Germany’s own trade balance is more substantial.