European Central Bank research estimates a 0.93 two-year GDP multiplier from higher defence spending

The European Central Bank published an Economic Bulletin article assessing the macroeconomic impact of higher government defence spending using a suite of ECB semi-structural and dynamic stochastic general equilibrium models. In a stylised scenario where government consumption rises from 2% of GDP in 2024 to 3% by 2028 and remains elevated for ten years, the models imply higher output with modest inflation effects, with an average two-year GDP multiplier of 0.93 and an average two-year impact on Harmonised Index of Consumer Prices inflation of 0.07 percentage points. Estimates vary materially across models, with output multipliers ranging from 0.42 to 1.13, while the average multiplier remains 0.93 four years after the shock and average inflation effects rise to 0.2 percentage points. Differences are traced to expectation formation and financing assumptions, distributional features, spending phasing and cross-country trade linkages: forward-looking expectations bring earlier tightening in financing rates and can lower multipliers, and anticipated labour tax financing dampens multipliers further as households curb consumption. In the heterogeneous-agent model, higher spending raises consumption for households at the bottom of the wealth distribution and lowers it for wealthier households, with larger effects if spending is targeted toward sectors employing low-income households. Pre-announced, backloaded spending yields substantially smaller GDP effects, while spillovers within the euro area depend on the instrument and its import content, with government investment (assumed to have a higher import share than consumption) generating more persistent positive spillovers.