Fiscal multiplier in Brazil: the role played by controls

There is no consensus on the size and significance of fiscal spending multipliers in Brazil, reflecting a broader debate in international literature. Different model specifications hinder comparisons across studies. We find that controlling for the monetary policy interest rate and a measure of sovereign risk leads to insignificant linear and state-dependent multipliers. However, excluding these covariates results in significant multipliers, albeit with a substantially poorer goodness-of-fit. The inclusion of sovereign risk markedly changes the conclusions. Our findings are robust across various robustness checks, including different estimates for the probability of being in a recessionary state and specifications normally used in the literature. Given the strong evidence of sovereign risk’s influence on the business cycle in emerging economies, particularly Brazil, its inclusion is essential for accurately studying fiscal multipliers.