Shock Propagation and the Fiscal Multiplier: the Role of Heterogeneity

Abstract

Advanced economies feature complicated networks that connect households, firms, and regions. How do these structures affect the impact of fiscal policy and its optimal targeting? We study these questions in a model with input-output linkages, regional structure, and household heterogeneity in MPCs, consumption baskets, and shock exposures. Theoretically, we derive estimable formulae for fiscal multipliers and show how network structures determine their size. Empirically, we find that multipliers vary substantially across policies, so targeting is important. However, virtually all variation in multipliers stems from heterogeneous incidence of policies across households' MPCs. Thus, maximally expansionary fiscal policy simply targets households' MPCs.