Abstract
We estimate the effects of government spending shocks during prolonged episodes of low interest rates, which we consider as proxy for the effective lower bound (ELB). Using a panel VAR model for 17 advanced countries, we find that both the government consumption and investment multipliers are significantly higher, and exceed unity, when interest rates are persistently low. Distinguishing between construction- and equipment-related government investments, we find that only the former raises output by significantly more when the ELB binds. This result can be explained by existing New Keynesian models featuring time-to-build constraints on government investment.
Highlights
Nowadays, many countries still struggle with the fallout of the global financial crisis, facing sluggish economic growth and inflation that is persistently below target
We find that the response of gross domestic product (GDP) to both a government consumption shock and government investment shock is significantly stronger in the presence of a binding effective lower bound (ELB) than in its absence
Fiscal policy is often called upon to support monetary policy, which is severely constrained due to interest rates being at their ELB
Summary
Many countries still struggle with the fallout of the global financial crisis, facing sluggish economic growth and inflation that is persistently (and sometimes far) below target. Albertini et al (2014), Drautzburg and Uhlig (2015), and Bouakez et al (2017) show that the fiscal multiplier at the ELB following a shock in productive government spending, like public investment, can be less than one This is because an increase in public investment reduces firms’ real marginal costs, which lowers inflation expectations and raises the real interest rate, thereby depressing private spending and reducing the fiscal multiplier.. We pool quarterly data for a sample of 17 advanced economies, covering the 1960Q1– 2017Q4 period, and use a panel VAR model and short-run (Cholesky) restrictions to identify fiscal innovations and estimate government spending multipliers, in the spirit of Beetsma et al (2008), Beetsma and Giuliodori (2011), and Ilzetzki et al (2013) We find that both the cumulative government consumption and investment multipliers are significantly higher, and exceed unity, when interest rates are persistently low.
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