Nordic Economic Policy Review 2024

The paper deals with a key question fiscal policymakers around the world constantly face: How much do changes in government spending, tax levels, or government debt (or a combination of these factors) affect economic activity? The answer is usually quantified in terms of “fiscal multipliers”, i.e. the percentage change in output relative to the percentage change in spending or taxes.

Fiscal multipliers play an important role in conducting fiscal policy in Norway despite our large sovereign wealth fund. The Norwegian fiscal guideline, which limits withdrawals from the fund to finance non-oil budget deficits, explicitly states that fiscal policy must focus on smoothing out economic fluctuations to ensure sound capacity utilisation and low unemployment. This pushes the effects of fiscal policy on economic activity to the forefront of policy discussions, and the national budget has contained such estimates for several years now. A good understanding of this issue hinges on reliable estimates of fiscal multipliers and modelling of what factors affect them.

The paper provides a good overview of selected research on fiscal multipliers. It reviews several articles, focusing on three papers co-authored by the authors of this survey: Brinca et al. (2016), Brinca et al. (2021) and Brinca et al. (2023), all of which present stylised empirical facts about fiscal multipliers and show how a neoclassical heterogeneous agent model might explain these.

The models presented in the three main papers reveal a close link between the size of fiscal multipliers and the aggregate elasticity of labour supply. In different ways, they show how the distributions of wealth and income affect this link. Here are two examples to exemplify this:

This quote from the paper summarises it well: “[Credit-constrained] consumers have less of an elastic labour supply response to fiscal policies that change their future income but more of an elastic response to policies that change their current income.”

The authors argue that these mechanisms explain why countries with above-average wealth Gini coefficients appear to have higher “traditional” fiscal multipliers, while those with high income inequality appear to have larger fiscal multipliers during periods of debt consolidation.

The authors do not just review the literature; they also make the results more relevant for the Nordic countries by applying the regression results from Brinca et al. (2021) to measure the fiscal multiplier of debt consolidation periods for various European countries. These calculations imply lower-than-average fiscal multipliers for most of the Nordic countries as a result of their low levels of income inequality.

My discussion of the paper revolves around three questions. Since the literature review is, to a large extent, a survey of three papers co-authored by the authors of the summary, it inevitably becomes a mix of comments on the paper itself and on the three main papers in the survey.

First, are there other, more relevant, fiscal experiments? The papers surveyed (and the models described) tend to assume that higher government spending is financed either by debt or by lump-sum taxation. Unfortunately, lump-sum taxes are rarely available in “real life”. I would welcome an investigation of how the link between inequality and fiscal multipliers changes if spending is financed by distortionary taxes, e.g. a progressive tax scheme. If this means credit-constrained households are affected less by higher government spending in the experiment, the link between the fiscal multiplier and wealth inequality might be weaker.

Second, is the distinctiveness of the Nordic countries exaggerated? The paper states that Nordic countries are characterised by high wealth inequality and low income inequality, making them ideal countries to draw implications in the light of the research surveyed. This seems to be a stretch, considering the statistics reported in the paper itself. While it is clear from Table 3 in the paper that the Nordic countries have a low level of income inequality, the picture is less clear for wealth inequality. The wealth Gini coefficients reported show that Denmark and Sweden have relatively high levels of inequality, while Iceland is close to the EU average, and Norway and Finland are below it. This means that it may be harder to draw an exact conclusion from the literature survey regarding the size of fiscal multipliers in the Nordic countries as a group than the impression given by the paper.

Third, are there other factors that make the Nordics more distinct? This paper focuses on how distributions of income and wealth may matter for the size of fiscal multipliers. The mechanism proposed for the stylised empirical facts presented is that the aggregate elasticity of labour supply is sensitive to the distributions of wealth and income. However, many interesting characteristics of the Nordic countries that may play a significant role in determining fiscal multipliers are left unexplored. For one thing, all of the Nordic countries have relatively open economies. Ilzetzki et al. (2013) show that the degree of openness may make the fiscal multiplier drastically smaller. Further, the Nordic countries have generous welfare states and, thus, a high level of income protection, which should reduce the need for precautionary savings. This could potentially alter the key mechanism in the main articles surveyed in the paper. Finally, the Nordic countries are also relatively highly unionised, which could change how the labour market functions and the aggregate labour supply elasticity.

The paper gives a nice and efficient review of selected research on fiscal multipliers but with a somewhat limited perspective. The Nordic countries share many characteristics, such as openness to trade, generous welfare states, high levels of unionisation and low levels of income inequality, all of which may matter for the size of fiscal multipliers. This paper summarises research that analyses the impact of income and wealth inequality on fiscal multipliers in neoclassical overlapping generations models. In these, the size of the multiplier depends critically on the elasticity of labour supply. Given other credible dimensions that could be explored, it is not clear that the levels of income and wealth distribution are the key dimensions that make fiscal multipliers in Nordic countries different from the international average. Future research on this topic would be highly appreciated by myself and, I am sure, other policymakers.

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.

Ilzetzki, E., Mendoza, E.G., & Végh, C.A. (2013). How big (small?) are fiscal multipliers? Journal of Monetary Economics, 60(2), pp.239-254.