2015 Series • No. 15–9
Research Department Working Papers
Output Response to Government Spending: Evidence from New International Military Spending Data 
Fiscal policy, among other measures, was widely used to stimulate employment and to put the U.S. economy back on track in response to the Great Recession and in a number of previous recessions in both the United States and in Europe. It is striking how much disagreement there was-and still is-among policymakers and academics alike about the inner workings of fiscal policy and its effect on output and employment. Estimating fiscal multipliers is methodologically challenging, as government spending often reacts to current or anticipated changes in economic conditions, and requires bold identifying assumptions. Barro (1981), Hall (1986, 2009), Rotemberg and Woodford (1992), and Barro and Redlick (2011), among others, rely on military spending as an exogenous component of government expenditure. However, in the United States after World War II (and even more so after the Korean War), there has not been enough variation in military spending to estimate the multiplier with a high degree of precision. This paper uses data from a large panel of countries with significant time variation in military spending to shed light on the magnitude of the government spending multiplier.
Key Findings
- The pooled government spending multiplier is small: below 0.2. This estimate masks substantial heterogeneity: the debt-financed spending multiplier is larger and can be well above 1 if monetary policy is accommodative.
- The multiplier is especially large in recessions and when the government purchases durables.
- The authors find substantial heterogeneity across countries, with the spending multiplier larger in advanced economies and in countries with a fixed exchange rate.
- The output response to government spending persists for about two to three years.
Implications
These findings suggest that the effectiveness of fiscal policy depends largely on the economic environment, policy implementation, and the central bank's response, and that the small multipliers found in historical or pooled data are a poor guide to evaluating the effectiveness of a specific stimulus program.
Abstract
Using 25 years of military spending data from more than a hundred countries, this paper provides new evidence on the effect of government spending on output. Following a popular assumption that military spending is unlikely to respond to output at business-cycle frequencies—and exploiting variation in military spending of a significantly larger magnitude than in the previous literature based on U.S. data—we find that the pooled government spending multiplier is small: below 0.2. This estimate, however, masks substantial heterogeneity: the debt-financed spending multiplier is larger and can be well above 1 if monetary policy is accommodative. The multiplier is especially large in recessions and when the government purchases durables. We also document substantial heterogeneity across countries with the spending multiplier larger in advanced economies and in countries with a fixed exchange rate. The output response to government spending persists for about two to three years. These findings suggest that the effectiveness of fiscal policy depends largely on the economic environment, policy implementation, and the central bank's response, and that the small multipliers found in historical or pooled data are a poor guide to evaluating the effectiveness of a specific stimulus program.