increase in government spending raises real GDP statistically significantly over the long term when government debt is at its (country-specific) minimum and has only insignificant effects when government debt is at its (country-specific) maximum.

In general, these conditional multipliers suggested by our results as well as previous studies conditioning on government debt are somewhat smaller than those estimated in studies that condition on other factors (Table 2). Especially recent studies that condition on recessions have found at times very large multipliers in advanced economies. Several have estimated peak fiscal multipliers during recessions in the range of 3-4 (Bachmann and Sims 2012, Auerbach and Gorodnichenko 2012 and 2013, Candelon and Lieb 2013). In a literature survey of earlier U.S. evidence, Ramey (2011) puts multipliers during a severe recession “at the upper bound of this [0.8-1.5] range,” notwithstanding considerable uncertainty about the estimates. Much of this evidence rests on U.S. data. However, in Europe as well, during the 2009-11 recessions in the wake of the global financial crisis, fiscal stimulus packages have been attributed with multipliers above 1 (Blanchard and Leigh 2014).<sup>25</sup> When we condition our multiplier estimates on recessions as well as government debt, we also find that multipliers can be above 1, at least for countries in the bottom quintile of government debt.<sup>26</sup>

# 6. Conclusion

A growing literature has documented how weaker government finances reduce the effectiveness of fiscal policy, i.e. fiscal multipliers. In this paper, we complement this literature by analyzing the empirical relevance of the two theoretical channels through which the fiscal position impacts the size of fiscal multipliers. Specifically, we study the Ricardian channel where households reduce consumption in anticipation of future fiscal adjustments during times of high debt; and the interest rate channel where increased investors’ perception of credit risks, raises sovereign credit risk and economy-wide borrowing cost, thereby weakening private domestic demand. We deploy an empirical model that allows us to trace the effects of fiscal shocks not only on private consumption and CDS spreads (as a measure of risk premia) but also on output. By bridging the response of consumption, CDS spreads and output to fiscal shocks, we explicitly establish the relevance of Ricardian and interest rate considerations (i.e. private consumption and borrowing cost effects) as the two channels for a government’s fiscal position to matter for fiscal multipliers (i.e. output effects). We also undertake a wide range of exercises to show the robustness of our findings with respect to the relevance of these channels.

Future research can usefully focus on three issues. First, while some earlier theoretical studies considered each channel separately, there has been no study exploring how the two channels operate jointly in a general equilibrium framework. This type of work could provide insights about the relative strength of each channel in response to different types of shocks. Second, one could study whether the two channels function differently in open economies in the context of a multicountry DSGE model. Finally, it would be useful to study the relevance of the two channels in a framework that allows fiscal-monetary policy interactions. In particular, one can assess how the use of monetary policy affects the roles of the two channels during periods of weak fiscal position.

> 25 Conversely, OECD fiscal consolidation packages have been estimated to have long-term multipliers close to 2 (Favero, Giavazzi and Perego 2011).

> 26 Four EU countries in the sample entered the 2008-09 recession with general government debt in the bottom quintile of the sample.

14