Are the Effects of Fiscal Policy Asymmetric?

Economic research on the size of the fiscal multiplier has assumed that the effects of changes in government spending are symmetric — that is, they influence economic output to the same degree whether the change is an increase or a decrease. Richmond Fed research indicates that this is not the case; the fiscal multiplier does vary according to the direction of the fiscal action and also varies with the stage of the economic cycle. This finding sheds light on likely outcomes of fiscal policies and helps account for inconsistent estimates of the multiplier in the literature.

Following the economic crisis of 2008-09, the use of fiscal stimulus in the United States and other industrialized countries led to a resurgence of interest in the size of the "multiplier" — roughly speaking, the effect on total economic output of a one-dollar increase or decrease in government spending or taxation. Interest in this question was further motivated in the 2010s by contractionary fiscal policies in continental Europe, which were implemented in response to rising levels of public debt. Estimates of the size of the multiplier have been inconsistent, with results in recent research ranging from 0.5 to 2.0. With some justice, the effect of fiscal stimulus or contraction on output has been termed "the foremost academic and policy dispute of the day."¹

Economic research on this question has assumed that the effects of fiscal policy shocks are symmetric; that is, a dollar of fiscal stimulus has been assumed to have the same multiplier as a dollar of fiscal contraction. Yet in the context of monetary policy, economists have long theorized that the effects of monetary stimulus and contraction are asymmetric, with monetary contraction having a larger effect on output — a view to which recent empirical research has lent support.² Might the same be true of fiscal policy?

Two of the authors of this brief, Barnichon and Matthes, have used a new statistical methodology to investigate whether the size of the multiplier varies on the basis of whether the fiscal shock is positive or negative. Their methodology also enables them to assess whether the multiplier is different during a recessionary stage of the business cycle or a nonrecessionary stage. The findings of this research offer a path for reconciling the inconsistent results of earlier research and provide support for the hypothesis of an asymmetric multiplier.³

Detecting Asymmetry in the Fiscal Multiplier

The research by Barnichon and Matthes employs a statistical methodology that they term "functional approximation of impulse responses," or FAIR. This approach facilitates the incorporation of nonlinearity into models, including the testing of multiple nonlinearities jointly — such as allowing for estimates to depend on whether the sign of a fiscal shock is positive or negative and at the same time allowing for estimates to depend on whether the shock takes place within an expansion or recession.⁴

The authors assume that the fiscal policy shock is structured as a temporary, possibly deficit-financed change in government purchases. They estimate the multiplier using two of the principal approaches in the literature to identifying fiscal shocks — the Auerbach and Gorodnichenko vector autoregression (VAR) approach and Ramey's narrative approach.⁵ Under both approaches, they find that the multiplier for contractionary shocks to government spending, which they term m−, is greater than 1.0 throughout the business cycle and that it is at its peak during recessions. With regard to expansionary fiscal shocks, the ones most often associated with fiscal policy, they find that the multiplier m+ is around 0.5 and is not statistically different in recessions than in nonrecessionary periods. (See Figure 1 below.)

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