Effective demand, wages and prices, and the multiplier

Abstract

The calculation of multipliers is the core of impact analysis with input–output (IO) models. Given this focus of IO modeling on the multiplier, it is remarkable that IO analysis has not contributed to the recent macroeconomic debate on fiscal multiplier heterogeneity. This heterogeneity stems from differences in consumption reactions to income shocks and from downward wage rigidity. Both features are absent in most IO models. In this paper, a macroeconomic IO model with a wage function is set up, where at high unemployment rates, downward wage rigidity allows for large real income and multiplier effects. At full employment, demand shocks mainly induce price adjustments. The model reveals GDP multiplier heterogeneity in line with the recent macroeconomic literature, ranging from 0.3 (boom) to 1.4 (recession). The GDP multiplier result of the standard type II model even outperforms the multiplier in the recession case and therefore is most probably biased.