The European Central Bank has published a working paper examining how public debt affects the effectiveness of discretionary fiscal policy. Combining empirical evidence and a calibrated heterogeneous-agent New Keynesian model for the United States, the paper finds an inverse relationship between the level of public debt and government-spending multipliers, implying smaller output gains from fiscal stimulus when debt is high. The paper notes that it does not necessarily reflect the ECB’s views. Empirically, state-dependent multipliers estimated using military spending news shocks decline as the lagged domestic public debt-to-GDP ratio rises, with an illustrative first-horizon multiplier of 0.41 at 150% debt-to-GDP versus 0.73 at 50%. A panel exercise for 24 OECD economies similarly shows weaker output responses to fiscal expansions in country-periods with high domestic debt shares compared with low-debt states. In the model, higher debt increases households’ liquid asset holdings and raises real interest rates, reducing intertemporal marginal propensities to consume and weakening fiscal transmission; a decomposition attributes more than four-fifths of the fall in the aggregate MPC to the interest-rate or factor-price channel rather than changes in the wealth distribution.
European Central Bank working paper links higher domestically held public debt to weaker fiscal multipliers via lower intertemporal MPCs
The European Central Bank published a working paper analyzing public debt's impact on discretionary fiscal policy effectiveness. Using a New Keynesian model and empirical data, the study finds higher public debt correlates with reduced government-spending multipliers, indicating smaller output gains from fiscal stimulus. The findings highlight that increased debt raises real interest rates and reduces consumption propensities, weakening fiscal transmission.