Nordic Economic Policy Review 2024

The article by Hans Holter and Ana Ferreira draws together previous studies that have analysed the role of income and wealth distribution as the determinants of fiscal multipliers. Based on these findings, they outline implications for fiscal stimulus policies in the Nordic countries. The main outcomes from the papers studied are that, first of all, fiscal multipliers vary significantly over time and space. Second, the previous studies show that countries with high wealth and income inequality have larger fiscal multipliers, and the multiplier is larger in the event of a spending shock. Hence, expansion/contraction of government spending results in larger/smaller multipliers. Furthermore, the intertemporal substitution of labour increases with wealth, resulting in a situation where credit-constrained and low-income agents have less elastic labour supply responses to fiscal policies that change future income but more elastic labour supply responses to fiscal policies that change current income. One key result for the Nordic countries is that they are characterised by high wealth inequality but low income inequality, both of which are associated with large numbers of credit-constrained and low-wealth households. Hence, it is legitimate to expect fiscal stimulus programmes to have a significant impact and increase consumers’ current income and less of an impact on future income. In empirical results based on a sample of OECD countries, the estimates of fiscal multipliers from consolidation programmes range from 0.98 to 1.47 in the Nordic countries but from 1.20 to 1.77 for the sample as a whole, indicating quite a remarkable difference in absolute terms.

The main suggestions in this paper are based on three papers by Pedro Brinca and a varying set of his co-authors, one of whom, for each paper, is Hans Holter. In Brinca et al. (2016), the main focus is on a case where an increase in current government spending is financed by a lump-sum tax. In this specific situation, the authors find that the fiscal multiplier is larger in economies with more credit-constrained consumers and that countries with greater wealth inequality have more credit-constrained households and, therefore, larger fiscal multipliers. On the other hand, in Brinca et al. (2021), the authors find that during periods of fiscal consolidation, there is a positive correlation between higher income inequality and the size of fiscal multipliers (negative effect on current output through a future income effect) and that the effects of fiscal consolidation are greater in economies with higher income risk and fewer credit-constrained consumers. Finally, Brinca et al. (2023) find that the fiscal multiplier is larger during spending shocks (expansive/contractionary shocks result in larger/smaller multipliers), and this holds true across time, countries and types of shocks.

In terms of content, one of the most interesting tables in the paper is Table 3: ‘Income and wealth inequality by country’, which clearly highlights the fact that in Nordic countries, the income inequality (Gini) is much smaller on average than in the other countries, but that the wealth Gini is clearly higher in some cases (especially in Denmark and Sweden). One of the questions that naturally arises from this finding is what the time variation is in the inequality measures, especially for wealth inequality, and how might that affect the results? Another interesting question might be the role of household debt, which has been an increasing long-term problem, at least in Finland. In any further analyses, it would, therefore, be interesting to look at the role played by controlling the share of housing market wealth in the overall (gross) wealth, and in the case of net wealth, also the role of mortgage debt, i.e., housing loans.

As a more general suggestion for further studies, the role of the level of general government debt may be relevant to be taken into account as well because recent studies have found it to be very important in determining the size of fiscal multipliers. For example, Eminidou et al. (2023) find that the effects of fiscal policy shocks vary depending on the level of public debt in an economy. Furthermore, according to their results, it is essential to control for both the cross-sectional and time-serial high-debt and low-debt states when analysing the size of fiscal multipliers. To put it more precisely, in their analyses of the euro area economies, cross-sectional debt variation is more important than time-serial debt variation in driving the differences in how macroeconomic variables respond to government spending shocks. Other recent studies on the role of public debt in fiscal policy efficiency include the papers by Geiger et al. (2022), Gornicka et al. (2020), and Huidrom et al. (2020).

The results in the Holter and Ferreira paper suggest that more detailed practical policy initiatives, especially in the Nordic countries, could be based on the following proposals: First, policy makers could perhaps devote more discussion to targeted government spending, i.e., increasing government spending in the areas that directly benefit credit-constrained consumers, as this could lead to larger fiscal multipliers. This could include an even closer focus on social welfare programmes, affordable housing and access to credit facilities. A second possibility could be to make the tax system at least a bit more progressive – especially for capital income taxes – in order to address wealth inequality. This could also affect the number of credit-constrained households and potentially affect the fiscal multiplier, especially in the long term. A third possibility would be to consider the timing of fiscal consolidation more carefully. In other words, when implementing fiscal consolidation, the time frame and the income inequality. If income inequality is high, the negative effects on output may be larger. Thus, consolidating during a period of lower income inequality might be more favourable. This is also related to the importance of income risk mitigation by, for example, drawing up policies to reduce income risk in order to lessen the adverse effects of fiscal consolidation in economies with higher income risk.

Two other important implications from these results related to the theme of NEPR2024 are that policy makers should pay close attention to both shock responsiveness and cross-country collaboration, especially in the Nordic context. In other words, they should be more prepared to adjust fiscal policies in response to the size and type of consumption/spending shocks. Expansive shocks may require different fiscal responses than contractionary ones, and international collaboration on fiscal policy could be beneficial since the effect of the fiscal multiplier varies across countries and time. Sharing best practices and learning from different countries’ experiences might lead to more effective policies. These suggestions could perhaps help optimise the fiscal multiplier’s impact while paying due heed to the economic conditions when designing fiscal policy and measures.

The NEPR2024 paper by Holter and Ferreira provides excellent insight into recent research about the distribution of income and wealth as determinants of fiscal multipliers and the implications for economic policy in the Nordic countries. As the Nordic countries are characterised by high wealth inequality and low income inequality, two features that are both associated with large numbers of credit-constrained and low-wealth households, it is expected that fiscal stimulus programmes will have a significant impact when consumers’ current income is increased and less of an impact when future income is increased. However, as highlighted in this discussion note, it might be relevant in future studies to focus on questions such as the roles of both household and government debt and how they vary in countries over time since there are big differences between the Nordic countries.

Brinca, P., Faria-e-Castro, M., Ferreira, M.H. & Holter, H. (2023). The nonlinear effects of fiscal policy, Federal Reserve Bank of St. Louis working paper 2019-015F.

Brinca, P., Ferreira, M.H., Franco, F., Holter, H.A. & Malafry, L. (2021). Fiscal consolidation programs and income inequality. International Economic Review, 62(1), 405 - 460.

Brinca, P., Holter, H.A., Krusell, P. & Malafry, L. (2016). Fiscal multipliers in the 21st century. Journal of Monetary Economics, 77, pp.53-69.

Eminidou, S. Geiger, M. & Zachariadis, M. (2023). Public debt and state-dependent effect of fiscal policy in the euro area, Journal of International Money and Finance 130, 102746

Geiger, M. & Zachariadis, M. (2022). Consumers’ updating, policy shocks, and public debt: An empirical assessment of state dependencies, Macroeconomic Dynamics, 26, 2104–2140.

Górnicka, L., Kamps, C., Koester, G. & Leiner-Killinger, N. (2020). Learning about fiscal multipliers during the European sovereign debt crisis: evidence from a quasi-natural experiment, Economic Policy, Volume 35, Issue 101, 5–40

Huidrom, R., Kose, M. A., Lim, J. J. & Ohnsorge, F. L. (2020). Why do fiscal multipliers depend on fiscal positions? Journal of Monetary Economics 114, 109-125