The Fiscal Arithmetic of Rearmament

Fiscal and macroeconomic consequences of the ongoing surge in defense spending across OECD countries

Ben Conigrave and Young-Hyun Shin examine how the size and durability of output effects vary depending on how rearmament is financed, the composition of military purchases, countries’ industrial structures, the macroeconomic context, and what governments should do to ensure lasting gains to productive capacity.

This is a comprehensive survey and synthesis paper rather than a single-model paper. The authors draw on three complementary approaches:

1. Empirical literature review: A systematic survey of defense spending multiplier estimates from time-series and panel studies, covering both US and international evidence.
2. Macro model simulations: Compilation of results from semi-structural and DSGE models used by the ECB, European Commission, and national central banks.
3. Descriptive and structural analysis: Examination of OECD/NATO/SIPRI data on defense spending trends, composition, industrial structure, trade in military equipment, and fiscal positions across member countries

Findings

Near-term effects: Most empirical estimates of defense spending multipliers fall in the range of 0.6 to 1.0, meaning defense spending boosts GDP but typically less than one-for-one. Model-based estimates for European economies tend toward the lower end, reflecting high import content of arms purchases, tight labor markets, and the anticipated need for future fiscal consolidation.

Factors driving heterogeneity in outcomes include:

• Financing method: Debt-financed spending yields higher multipliers than tax- financed spending. Multiplier estimates for tax increases in OECD countries often range from -2 to -3.
• Spending composition: Equipment spending has a smaller domestic multiplier in import-dependent countries, while spending on personnel or local infrastructure generates larger domestic effects.
• Economic slack: Multipliers are larger when output is below potential. Most OECD economies had negative output gaps in 2025.
• Monetary policy: Active tightening in response to the defense shock reduces multipliers significantly.

Long-run effects: Lasting output gains require defense spending to expand productive capacity through R&D spillovers to civilian industries (e.g., GPS, internet, AI) or infrastructure investment. However, these benefits may be offset if defense firms crowd out skilled workers or private R&D from more productive civilian uses.

Distributional/structural concerns: Economic benefits from defense purchases can be highly concentrated, benefiting a small number of firms and sectors. The paper flags that procurement reforms, including competitive tendering, performance-linked contracts, and cross-border EU coordination, are essential to spread gains and contain fiscal costs.

Fiscal and macroeconomic impacts of defence spending
Authors: Ben Conigrave, Young-Hyun Shin
From: OECD

Who pays for Europe’s rearmament?

How should European governments finance a large, permanent increase in defense spending  and who ultimately bears the cost? This is the question, Mathieu Boullot, Christophe Cahn, Edouard Challe, and Julien Matheron are attempting to answer in this paper. In addition, they investigate whether there exists a fiscal adjustment strategy that can simultaneously limit the macroeconomic drag (crowding-out of private consumption) and prevent a worsening of consumption inequality, or whether these two goals are in fundamental tension.

The authors build a quantitative OLG-HANK model, which generates household heterogeneity along two dimensions:

1. Across cohorts: life-cycle variation in productivity, labor supply, and saving behavior
2. Within cohorts: idiosyncratic productivity shocks producing income, employment, and wealth inequality

A distinctive feature is the model’s detailed fiscal structure, encompassing taxes on labor, capital, and consumption, a pay-as-you-go pension system, transfers, and explicitly modelled public debt. To match observed asset return differentials, the model also introduces a preference for liquid assets (e.g., government bonds), which allows it to realistically capture fiscal capacity and government borrowing costs.

The spending shock is calibrated to the 2025 NATO core defense spending target, and the authors simulate a range of individual and combined financing strategies: raising the retirement age, reducing pension benefits, and increasing labor, capital, or consumption taxes.

Findings

The central result is a trade-off between aggregate efficiency and distributional equity across all fiscal instruments studied:

• Raising the retirement age is the most macroeconomically efficient option as it expands the workforce and tax base, financing much of the spending increase with minimal aggregate consumption loss.
• Increasing labor tax progressivity shifts costs toward high-income households but weakens saving incentives, while consumption taxes spread the burden broadly but regressively.

Aggregate and Distributional Implications of a Military Buildup
Authors: Mathieu Boullot, Christophe Cahn, Edouard Challe, Julien Matheron
From: Banque de France, Paris School of Economics