Fiscal Policy Multipliers in Small States

This paper estimates fiscal policy multipliers for small states using two distinct models: an empirical forecast error model with data from twenty-three small states across the world, and a dynamic stochastic general equilibrium (DSGE) model calibrated to a hypothetical small state’s economy. We find that, in the short term, multipliers for government consumption and investment in small states are both about 0.4, on average, for empirical and DSGE baseline results, and they are affected by imports as a share of GDP, the level of government debt, and the economy’s position in the business cycle, among other factors. In the medium to long run, while fiscal policy using government consumption is ineffective, government investment has a multiplier of about 0.7, on average, for empirical and DSGE baseline results. These results are robust to different model specifications and characteristics of small states. Inability to affect GDP using government consumption could be frustrating for policymakers when an expansionary policy is needed but encouraging when they consider fiscal consolidation.