Public expenditure multipliers in recessions : evidence from the Eurozone

During the sovereign debt crisis, many Euro countries have deployed "austerity packages" implementing structural reforms and cutting government spending. Such policies should have led to an initial decline in GDP followed by recovery and a reduction of the debt to gdp ratio. Key to this outcome is the size and sign of expenditure multipliers when the economy is in a recession. We estimate, for the Eurozone countries, expenditure multipliers in recession and expansion using the linear projection approach and forecast errors to identify exogenous expenditure shocks. The empirical evidence suggests that, in a recession, an increase in government spending will be effective in boosting aggregate demand, crowding-in private consumption in the short-to-medium run, without raising the debt to gdp ratio but rather decreasing it. The opposite applies in expansions. Estimates also show that expenditure multipliers, in a recession, are larger in high debt/deficit countries than in low debt/deficit countries. In a recession,fiscal consolidation based on expenditure cuts would have both short and medium run contractionary effects.