Quantifying fiscal multipliers in New Zealand: The evidence from SVAR models
Fiscal policy has a substantial impact on aggregate demand both directly via government spending, and indirectly via changes to the disposable income of households and businesses though variations in taxation and transfers (e.g. superannuation). For fiscal policy-makers to accurately forecast the impact of fiscal policy, and for monetary policy-makers to respond appropriately, both need to understand the likely aggregate impact of fiscal changes on economic activity over time. Furthermore, this impact could vary across different fiscal policies, e.g. changes in government spending versus tax changes.
To address these questions, this Analytical Note uses Structural Vector Auto-Regression (SVAR) models to quantify the historical magnitude of fiscal policy changes on economic activity in New Zealand. The economic impact is measured by the GDP multiplier, which shows the percentage-point (ppt) change in GDP in response to an increase in government expenditure or decrease in revenue equivalent to 1 percent of GDP. The analysis in this Analytical Note builds on previous empirical studies by using updated data for the period 1990 to 2017 and estimating multipliers for specific components of fiscal policy rather than just aggregate multipliers. This Note also brings more attention to the interaction of monetary and fiscal policy and how the results can be applied in macroeconomic forecasting.
We find that New Zealand’s fiscal multipliers are comparable to other developed countries and that different fiscal policies have very different economic effects. At the aggregate level, the GDP multiplier in the first year for an increase in aggregate government spending (0.24 ppts) is larger than for a decrease in taxes net of transfers (-0.10 ppts), in line with previous New Zealand studies. At the more disaggregated level, the multiplier for a change in public consumption is large and positive (0.82 ppts), while the multiplier for public investment is negative (-0.59 ppts). The weak multiplier for an increase in public investment appears sensitive to several assumptions, highlighting concerns around the accuracy of this estimate. An increase in transfers and decrease in total tax revenue have large multiplier effects, 0.76 ppts and 1.29 ppts respectively.
The duration of the GDP response to a change to fiscal policy also varies depending on the type of policy used. The impulse on aggregate demand from an increase in transfers and public investment appears to be short-lived, with the peak impact occurring within the first two quarters. On the other hand, the positive impact on GDP from an increase to public consumption or decrease in tax revenue is more long-lasting.
The results can provide a useful indication of how future policy changes could affect the economy, but it should be noted that the results of the model have been extracted from a 30-year period, and hence represent the dynamics that one would expect on average. If the nature of the economy today is significantly different from its history, then users need to take this into consideration when applying the estimates. The estimated multipliers for government spending and its components appear more robust to the choice of variables, identification assumptions and sample period compared with taxes and transfer spending. The endogeneity problem between economic conditions and taxes and transfers may be more serious than it is for government spending.