Lost in consolidation? Declining public investment, multiplier effects and alternatives to the path of fiscal consolidation in Portugal

Abstract

This paper deals with one of the most pressing concerns that Eurozone periphery economies will face in the near future: how to achieve a sustained recovery from the COVID-19 crisis while dealing with growing public debt-to-GDP ratios. The paper assesses the macroeconomic relationship between public spending, economic growth and debt sustainability. We use a TSLS method to perform the econometric estimation of the public spending multiplier for a panel of 11 Eurozone economies over the 1995–2019 period. We find evidence that the multiplier is positive and close to 1,8, suggesting that the benefits of promoting public investment exceed its initial financing cost. As a result, we conclude that debt sustainability is not only compatible with, but in fact improved by a more expansive fiscal policy and present an alternative policy path for the Portuguese economy in the 2021–2025 period based on this conclusion.