Fiscal multipliers and public debt in the UK

Introduction

Following on from my previous post, “The intelligent management of the public finances”, I thought it may be interesting to ascertain the UK’s overall fiscal multiplier value. After a quick survey on the topic, I discovered that economists have attempted this task but without much success it seems. This is despite the elaborate techniques they use  in their studies. The studies I have encountered seem  inconclusive and equivocal,  much like the search for proof of God’s existence or the search for the Higgs Boson.

So rather than attempting to detect and measure it through an elaborately constructed empirical study, I have attempted to estimate what its value SHOULD be, given known leakage values. We know that the fiscal multiplier specifies by how much the economy should grow in response to an injection of demand by the government.  We know that some of this additional demand will leak from the economy via taxation, saving and imports. So if these leakage values can be ascertained and shown to be stable from year to year, then it should be feasible to determine an accurate multiplier value.

Here are my results, which I have set out in a chart, along with other information and relevant parameters .

Multiplier chart with enlarged table

Estimating the actual multiplier values

A so-called complex multiplier was calculated so as to take account of all leakages, ie, tax, savings and imports.  By expressing each of the leakage separately as a percentage of GDP, an additive denominator is made possible, ie the multiplier was estimated as

1  ⁄  ∑ leakages

Sources

The leakages, which are expressed in decimal fractions of UK GDP, were sourced as follows:

Tax leakages: Guardian Newspaper;

Savings leakages:  Economy Watch website;

Import  leakages: The World Bank.

The public debt ratios, shown as decimal fractions in the table,  were sourced from www.ukpublicspending.co.uk

The ideal multiplier is calculated as the reciprocal of the public debt ratio, as described in a previous post. They indicate a threshold above which a multiplier’s value supports additional debt financed spending and a simultaneous reduction in the public debt ratio.

Commentary

The multipliers estimated for the four years average 1.23, approximately, and are not too dissimilar from year to year,  having a range of 0.09.  Clearly, these multiplier estimates may be wildly inaccurate for the following reasons:

  1. The leakage fractions were sourced second hand and hence loss of accuracy may arise due to this
  2. Injection of additional demand into the economy may change consumer behaviour, rendering the import leakage fraction in particular, obsolete. In my view, it is unlikely that the multiplier estimates are rendered invalid because of so-called Ricardian Equivalence.
  3. The current economic slump may have affected the leakage parameters used to determine the multiplier’s value. Tax rates may have changed, as may have savings rates.  Unfortunately, I could not find more up-to-date data to enable a slump adjusted multiplier to be estimated.

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