Government spending in Czechia has a largely positive impact, especially in a recession

Government spending has a largely positive impact in the Czech economy. Yet it tends to be stronger in times of economic recession and extraordinary crises, such as the Covid pandemic. This follows from the latest SYRI study, which analysed the impacts of government spending on the country’s economy in the years 1999 to 2024. The outcomes of the study underscore the importance of an active economic policy in times of extraordinary turmoil, when investments can help kick-start the economy.

When the state spends money - be it to repair roads, build schools or increase teachers’ salaries - this does not just mean that specific companies and people receive these funds. “The money keeps ‘turning’ in the economy: employees spend their wages at stores, businesses invest into production, suppliers hire new workers. The overall impact on the economy can thus be much greater than the original expenditure,”  explains the author of the study, Jan Čapek from SYRI and Masaryk University.

This effect is measured by a fiscal multiplier, meaning a number that indicates how much gross domestic product (GDP) will change when the government increases spending by one koruna (CZK). For instance, if it spends an extra CZK 1 million and GDP increases by CZK 1.2 billion, the multiplier has a value of 1.2. On the other hand, the effect can also be reversed, meaning that additional expenditure has a lower impact on the economy than its nominal value.

Knowing the fiscal multiplier is essential because without it, government decisions are based more on estimates than on properly founded analyses. “If the multiplier is high, it means that every additional state expenditure results in the higher growth of economic activity. On the contrary, a low multiplier suggests that government spending has a limited impact, for instance due to household savings, leakage into imports or crowding out of private investment,” says Čapek.

The current study indicates that the spending multipliers in the Czech Republic are in most cases positive, and indeed tend to by systematically higher in a recession than during expansion. On the contrary, during economic expansion, additional spending delivers only a limited growth effect and can contribute to inflation pressure. “Times of economic boom should therefore be used to consolidate public finances. The results of the study also show that the stronger use of discretionary measures - i.e. ‘brakes and accelerators’ - can improve macroeconomic outcomes if properly timed,” says Čapek.