Fiscal space and the size of the fiscal multiplier

This paper investigates the interaction between fiscal policy transmission and fiscal sustainability, captured through the concept of fiscal space. In order to measure the evolution of fiscal space over time we propose four indicators, drawing from different concepts available in the literature. We use these indicators to define periods of ample and tight fiscal space. We then estimate the effects of government spending shocks in the United States according to the level of fiscal space, for the period 1929:Q1-2015:Q4. The main result of the paper is that fiscal multiplier is above one when fiscal space is ample, while it is below one when fiscal space is tight. Moreover, such difference is always significant. This result is very robust across different identification methods and samples.