HOW CAN THE GOVERNMENT SPENDING MULTIPLIER BE SMALL AT THE ZERO LOWER BOUND?

Valerio Ercolani · João Valle e Azevedo

27 citations0/0 files storedMacroeconomic Dynamics

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Monetary Policy and Economic Impact Economic Theory and Policy Fiscal Policy and Economic Growth

Abstract

Some recent empirical evidence questions the typically large size of government spending multipliers when the nominal interest rate is stuck at zero, finding output multipliers of around 1 or even lower, with an upper bound of around 1.5 in some circumstances. In this paper, we use a recent estimate of the degree of substitutability between private and government consumption in an otherwise standard New Keynesian model to show that this channel significantly reduces the size of government spending multipliers obtained when the nominal interest rate is at zero. All else being equal, the relationship of substitutability makes a government spending shock crowd out private consumption while being less inflationary, thus, limiting the typically expansionary effect of the fall in the real interest rate. Subject to the nominal interest rate being constrained at zero, the model generates output multipliers ranging from 0.8 to 1.6.

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References

2007Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach 2007Understanding the Effects of Government Spending on Consumption 2012Measuring the Output Responses to Fiscal Policy 2011When Is the Government Spending Multiplier Large?2003Zero Bound on Interest Rates and Optimal Monetary Policy 2011Identifying Government Spending Shocks: It's all in the Timing*1990Fiscal Policy in General Equilibrium 2017Government Spending Multipliers in Good Times and in Bad: Evidence from US Historical Data

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2019Public investment fiscal multipliers: An empirical assessment for European countries 2022EXPECTATIONS, STAGNATION, AND FISCAL POLICY: A NONLINEAR ANALYSIS 2020Bargaining Power and the Phillips Curve: A Micro-Macro Analysis 2020THE GOVERNMENT SPENDING MULTIPLIER IN A MODEL WITH THE COST CHANNEL

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