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 2025-09-03
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.