Fiscal Sentiment Multiplier: When Confidence Crowds In, Until It Doesn’t

The fiscal sentiment multiplier can crowd in investment—if credit is open and demand credible
Japan’s new stimulus tests this channel amid record debt, higher yields, and shaky confidence
Aim spending at skills-linked, high-productivity sectors to avoid over-investment and lock in growth

Japan is now testing whether fiscal policy can still boost private investment, even as government debt is high and borrowing costs are at their highest since 2007. The new prime minister is promising fiscal actions and a faster increase in defense spending to 2% of GDP, even as gross public debt stands at about 230% of GDP. This is a live test of the fiscal sentiment multiplier—the idea that well-timed public spending can boost business expectations enough to spur private-sector investment rather than crowd it out. If stronger sentiment translates into bank credit and improved internal finances, economic output could rise beyond the initial spending. But if borrowing costs rise, lenders become more cautious, or companies hoard cash, similar spending may slow growth and increase deficits. Japan stands at this pivotal moment today.

The fiscal sentiment multiplier beats crowding out, until finance bites

A common criticism of active fiscal policy is crowding out: increased public spending raises rates and limits private investment. Yet growing research indicates a counteracting mechanism. When government spending rises, businesses often raise their sales expectations and invest more. This fiscal sentiment multiplier turns public spending into a driver of private investment rather than a rival to it. Recent studies show that business expectations can exceed actual demand, which is why the short-term boost appears significant in the data. Importantly, this boost isn’t automatic; it occurs when companies can access credit or use internal funds at reasonable costs. In periods with slack credit frictions, multipliers tend to be slightly above one. In times of weak conditions or uncertainty, where expectations respond strongly, and financing remains available, they can be larger.

Results vary based on the state of the economy. Across OECD economies, multipliers vary with the cycle phase, the monetary policy stance, and available fiscal space. They are typically smaller in stable times; in recessions or when monetary policy is supportive, they increase. Empirical studies have shown higher multipliers during downturns and when debt sustainability isn't an issue. As fiscal space shrinks or households anticipate future tax hikes, the multiplier declines. A further nuance comes from financial frictions: if banks tighten their standards or balance sheets are strained, the sentiment boost can hit a wall. Evidence from Italy, for example, indicates that multipliers are larger when financial stability is high and decrease as instability rises. This simple principle should be applied elsewhere: sentiment can attract investment, but only if finance enables it.

Japan as a test of the fiscal sentiment multiplier

Japan’s policy mix sets up a crucial scenario. The new prime minister has vowed to implement proactive fiscal measures and to increase defense spending swiftly. Markets have taken notice. Long-term yields have soared to 18-year highs over expectations of heavier bond issuance and potential rate hikes. The central bank has suggested it may buy bonds to curb disorderly moves, but the trend is slowly tightening. This situation—larger deficits, rising yields, and a central bank normalizing—determines whether fiscal sentiment translates into real investment or leads to higher interest costs. If the budgetary sentiment multiplier is effective, capital expenditure should rise even with slightly higher rates. If the mechanism is weak, the rising term premium will prevail, leading to disappointing growth.

Balance-sheet facts matter. Japan has one of the highest public debt ratios globally, estimated at around 230% of GDP by the IMF. However, Japanese companies also hold significant cash reserves and have enjoyed record profits during their recent reform push. Real interest rates remain low compared to historical standards, and bank lending attitudes, as shown in the Tankan and the Bank of Japan’s loan surveys, appear stable rather than tight. These signs can point in both directions. They suggest there is space for capital expenditure if sentiment improves. However, if companies do not invest now—despite having cash and pressure to use it from rising equity—the issue isn’t just the cost of capital; it’s also about confidence in sustainable demand. The multiplier will depend on whether planned spending convinces businesses that demand is real and lasting rather than temporary.

There is a final complication that should keep policymakers cautious. Household spending dipped this autumn, and the yen's decline has affected prices without causing a comparable rise in real activity. These are signs of fragile confidence. A substantial stimulus that boosts overall demand but fails to encourage private investment risks leaving the state with higher interest costs and little to show for it. On the other hand, a package that genuinely convinces firms—especially in tradables and technology—to advance multi-year investments could attract more investment than it displaces. The distinction isn’t ideological; it concerns the flow of finance and the credibility of demand.

Over-investment risk and how to aim sentiment at real productivity

The upside of a strong fiscal sentiment multiplier is clear. The downside, however, receives less scrutiny: over-investment. When optimism outpaces actual demand, firms may expand too quickly, misallocate resources, and lower returns. This risk is not hypothetical. Credit booms often foreshadow weaker future performance and a higher risk of crises. Japan’s own experience with “zombie” lending—where weak firms survive thanks to banks—illustrates how misallocated credit can impede healthy economic growth. If expansionary policy boosts spending by firms that ought to reorganize instead, the growth equation flips. In such scenarios, sentiment may still “work,” but it could steer investment toward low-productivity uses, undermining the very dynamism the policy aimed to foster.

That’s why how an expansion is designed matters as much as its size. Broad signals—such as overall stimulus levels—can alter expectations, but the type of spending influences where optimism settles. A rise in general procurement can inflate valuations, encourage mergers and acquisitions, and increase private spending without enhancing productivity. Japan's record merger and acquisition volumes this year signal a return of risk appetite, but they don’t ensure actual capacity growth in high-impact sectors. The more optimal target for sentiment is investment in industries that drive long-term growth: digital infrastructure, energy transition equipment, and research-intensive manufacturing. If fiscal signaling focuses on those areas, the multiplier will generate future profits rather than just marginal returns on outdated assets. If it shifts elsewhere, it might inflate balance sheets without advancing the frontier.

There’s also a sequencing issue. If rates rise as bond issuance expands, the first projects to drop out will be the marginal ones. The projects that remain are typically those with substantial external benefits or clear short-term cash flows. This bias can be beneficial when the pipeline is well-cultivated, but risky if credit is distorted. Studies of poorly performing firms indicate that a greater presence of weak companies over time can reduce the productivity of stronger ones. The solution isn’t to impose austerity for its own sake; it is to practice selective discipline. Tie support to performance and competition. Use temporary guarantees to price risk appropriately, and eliminate them quickly. Direct fiscal efforts to sectors where private investment is poised to grow yet hindered by coordination issues, instead of those primarily constrained by low returns. That’s how a fiscal sentiment multiplier can transform into a growth multiplier.

What does this mean now for education leaders and finance ministries

Education systems are central to this discussion. When sentiment-driven expansions succeed, they boost demand for skilled labor within months. This raises the value of vocational training, applied STEM pathways, and adult reskilling. When the fiscal sentiment multiplier fails, hiring slows, creating a backlog in the skills pipeline. The sector’s goal, then, isn’t to push for broad stimulus but to reduce barriers between optimistic firms and job-ready talent. In practice, this involves setting up apprenticeship pools with guaranteed seat purchases, integrating modular micro-credentials linked to specific capital projects, and connecting procurement to on-the-job training. Finance ministries can embed these connections: firms receiving public contracts or tax breaks should commit to funding apprenticeship ratios and report on training outcomes. The faster these commitments expand, the more credible the demand narrative becomes for both banks and CFOs.

University leaders and school districts should also see this cycle as a pivotal moment for balance sheets. With long-term rates rising from near zero, the era of cheap money has ended. Institutions can still fund energy retrofits and digital infrastructure at reasonable costs, but they should time their investments wisely. Align capital strategies with sectors likely to see lasting demand in a sentiment-driven recovery: semiconductor supply chains, green manufacturing, and AI services. Collaborate to design labs with employers ready to invest and secure multi-year internship programs. This way, if the macroeconomic scenario unfolds positively, education systems will be prepared; if it falters, investment will still enhance campus productivity—through lower energy bills and improved digital delivery—without relying on marginal enrollment to sustain itself.

Finally, both educators and policymakers should brace for uneven outcomes across regions and firm types. Large exporters with cash on hand have the best chance of responding positively to sentiment. Smaller domestic firms depend more on bank credit and face stricter collateral requirements. Japan’s loan surveys indicate no widespread tightening, but they don't guarantee equal access. Regions with colleges that can quickly certify skills, share resources with small and medium-sized enterprises, and organize joint training programs with banks and business associations will be the first to convert sentiment into job growth. This will create a more potent local multiplier with fewer misfires. That’s the real competition, starting within the education-finance relationship, not in the bond market.

Japan’s experiment won’t resolve every debate about fiscal policy. However, it can clarify one point. The fiscal sentiment multiplier is tangible enough to matter and fragile enough to fail. Today’s conditions pull in both directions: record public debt and rising yields call for caution; still-low real rates, stable lending behaviors, and substantial corporate cash reserves suggest that the pipeline remains open if demand is perceived as sustainable. If the proposed package convinces firms that long-term opportunities are imminent—because public spending enables private projects in productive fields—the crowd-in effect will prevail. If not, the deficit will grow, and the subsequent increase in borrowing costs will hit harder. The policy choice isn’t a simple one between expansion and restraint. It’s about how to focus confidence and keep financial pathways clear. Education leaders and finance ministries can make this choice clear, measurable, and swift. If they do, confidence won’t just rise—it will build on itself.

The views expressed in this article are those of the author(s) and do not necessarily reflect the official position of the Swiss Institute of Artificial Intelligence (SIAI) or its affiliates.

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