Fiscal Multipliers and Fiscal Sensitivities

To assist parliamentarians’ deliberations in the context of a post-COVID economic recovery, this blog post summarizes PBO’s estimates of potential impacts of government spending and tax measures on the Canadian economy. We also provide estimates of the sensitivity of the budgetary balance to various types of economic shocks.

Fiscal Multipliers

Fiscal multipliers provide an estimate of the potential impact of government policy measures on the economy.[i] They are defined as the impact on real gross domestic product (GDP) from a permanent one‑dollar increase in budgetary measures (that is, new spending or tax reductions).

Different macroeconomic models will typically generate different estimates of fiscal multipliers. Depending on the economic context, monetary policy may respond to new budgetary measures to prevent the economy from overheating and inflation rising above its target.

The economic context underlying our estimates assumes that broad immunity from the coronavirus has been achieved and public health restrictions have been lifted. In addition, the economy is assumed to be operating below its potential capacity and monetary policy does not respond to the new measures.

The table below summarizes fiscal multipliers based on the macroeconomic and fiscal model used in PBO’s September 2020 Economic and Fiscal Outlook (EFO).

Fiscal Sensitivities

PBO regularly provides estimates of the fiscal outlook’s sensitivity to three key economic indicators that drive our federal fiscal projection:  real GDP growth, GDP inflation and interest rates.[ii] 

In the context of the post-COVID economic recovery, the PBO expanded on that analysis by assessing the fiscal impacts of four upside shocks on the budgetary balance:

1. A permanent 1 per cent increase in the GDP price level [iii]
2. A permanent 1 per cent increase in real GDP [iv]
3. A permanent 1 per cent increase in employment [v]
4. A permanent 1 per cent increase in the level of labour productivity. [vi] 

The results of these shocks are summarized in the table below and are based on our September 2020 outlook.

In constructing the sensitivity estimates, we assume that changes in nominal GDP are proportional across income and expenditure components. Further it is important to note that these economic shocks are illustrative and simplifications of a complex and endogenous system. As such, these estimates should be considered stylized rules of thumb.