Government Spending Multipliers Research Articles

Government Spending Between Active and Passive Monetary Policy: An Invariance Result

Abstract This paper develops a new approach to analyze the relationship between the government spending multiplier and monetary policy. We embed measures of monetary policy activism into a nonlinear SVAR model. Our model allows the central bank to adjust its monetary policy regime in response to the economic conditions that arise after government spending shocks. We find that, regardless of the monetary policy regime at the time of a spending shock, the central bank adjusts its regime quickly and responds actively towards inflation only a few quarters after the shock hits the economy. This rapid response of monetary policy leaves medium-run multipliers ultimately unaffected by whether the initial regime was active or passive. For both initial regimes, our five-year multiplier estimates lie between 1.2 and 1.5. An apparent exception to this result is the zero lower bound period between 2008Q4 and 2015Q4-during which monetary policy kept nominal interest rates at zero. Our multiplier point estimates for that era are consistently larger than unity.

Estimating the dynamics of fiscal financing in emerging economies

<p class="MsoNormal" style="margin-top: 8pt; line-height: 14pt; text-align: justify;"><span lang="EN-US" style="font-family: 'Cambria',serif; mso-fareast-font-family: '等线 Light'; mso-fareast-theme-font: major-fareast; mso-bidi-font-family: 'Times New Roman'; color: black; mso-themecolor: text1;">I present a theoretical model and an empirical approach for jointly estimating the effectiveness of fiscal policy and the stochastic process of sovereign interest rate shocks. The theoretical model has features relevant to small open and emerging economies. Interest rate shocks affect the ability of firms to finance payroll expenses. This theoretical feature creates a propagation mechanism for interest rate shocks and affects government spending multipliers. This paper proposes a strategy for jointly estimating government spending multipliers and the interest rate shock process parameters.</span></p>

Does household debt affect the size of the fiscal multiplier?

Abstract Does household debt affect the size of the fiscal multiplier? We investigate the effects of household debt on government spending multipliers using a smooth transition vector autoregression model. Through generalized impulse response functions, we measure whether the effect of government spending on GDP is conditioned by different levels of household debt in Australia, Sweden, and Norway, three countries with high levels of household indebtedness, and in the world’s seven largest economies. Our results indicate that the short-term effects of government spending tend to be higher if fiscal expansion takes place during periods of low household debt. On average, the fiscal multiplier (on impact) is 0.70, 0.61, and 0.79 (percent of GDP) larger when the increase in government spending takes place during periods of low household debt for Australia, Norway, and the United States.

Local projections in unstable environments

This paper develops a local projection estimator for estimating impulse responses in the presence of time variation. Importantly, we allow local instabilities in both slope coefficients and variances. Monte Carlo simulations illustrate that the method performs well in practice. Using our proposed estimator, we shed new light on the effects of fiscal policy shocks and the size of government spending multipliers. Our analysis uncovers the existence of instabilities that were unaccounted for in previous studies, and links time variation in the multipliers to the size of government debt.

Recovery of 1933

When Roosevelt abandoned the gold standard in April 1933, he converted government debt from a tax-backed claim to gold to a claim to dollars, opening the door to unbacked fiscal expansion. Roosevelt followed a state-contingent fiscal rule that ran nominal-debt-financed primary deficits until the price level rose and economic activity recovered. Theory suggests that government spending multipliers can be substantially larger when fiscal expansions are unbacked than when they are tax-backed. VAR estimates using data on “emergency” unbacked spending and “ordinary” backed spending confirm this prediction and find that primary deficits made quantitatively important contributions to raising both the price level and real GNP after 1933. VAR evidence does not support the conventional monetary explanation that gold revaluation and gold inflows, which raised the monetary base, drove the recovery independently of fiscal actions.

Low interest rates and the predictive content of the yield curve

Does the yield curve’s ability to predict future output and recessions differ when interest rates and inflation are low, as was recently the case? We explore the issue using historical data going back to the 19th century for the US. This paper is similar in spirit to Ramey and Zubairy (2018), who look at the government spending multiplier in times of low interest rates. If anything, the yield curve tends to predict output growth better in low interest rate environments, though this result is stronger for RGDP than for IP.

Habit formation and the government spending multiplier

This paper explores the impact of habit formation on government spending multipliers (GSMs) within a New Keynesian framework, challenging the widely held belief that GSMs are significantly larger when nominal interest rates are low. We present a novel channel that affects the size of GSM by introducing deep habit preferences, which include consumption habits at the variety level. During periods of persistently low nominal interest rates, deep habits result in more moderate GSM levels, albeit still above 1. Furthermore, deep habits reduce the gap in GSM sizes between the constrained regime, in which the nominal interest rate is fixed at the effective lower bound, and the conventional regime, which is characterized by an endogenous Taylor-type nominal interest rate rule. This study emphasizes the importance of habit formation in understanding GSM mechanisms and contributes to the discussion of fiscal policy effectiveness in a low nominal interest rate environment.

The Government Spending Multiplier in the Presence of the Informal Sector

The Government Spending Multiplier in the Presence of the Informal Sector

Estimating tax and government spending multipliers in China

ABSTRACT In recent years, China has implemented unprecedented fiscal policies, prompting crucial questions: are tax cuts effective in stimulating output and is the output effect from tax cuts greater than government spending in developing countries? This article addresses this ambiguity by providing a novel method to identify China’s tax and government spending shocks in a SVAR framework. The results show that both tax cuts and increased government spending positively impact output. The estimated tax multiplier is 2.4 (3.6) after 8 (20) quarters while the government spending multipliers are 0.3 (0.8), suggesting that tax cuts have a greater impact on output than government spending. The results above survive after a set of robustness checks. The findings contribute to the ongoing debate on the effectiveness of fiscal policy tools in developing economies and suggest that targeted tax measures could be a potent instrument for stimulating economic activity.

On the numerical structure of local and nationwide government spending multipliers: what can we learn from the Greek crisis?

ABSTRACT It has been recognised that the fiscal multiplier is a function of structural features of the economy and policy reaction parameters. Moreover, the debate on the magnitude of the multiplier along the business cycle has also been the subject of disputed debates. On these grounds, we look at the Greek case by calibrating a NUTS-2 interregional general equilibrium model using data for distinct states of the Greek economy during the development of the recent crisis. Whether this matters for local and nationwide multipliers depends on qualitative differences in the numerical structure of the model. As governments have to decide how to conduct fiscal policy, our results on the Greek case provide insights to policymakers on the reach of their actions in a spatially integrated system.

Government spending multipliers: Is there a difference between government consumption and investment purchases?

This paper empirically studies the U.S. multiplier effects of government investment, government consumption and total government purchases on output. We explore dependencies of the multipliers on states of the economy, measured in different ways. Using local projections with instrumental variables, we find that a model without state-dependencies and using total government spending (instead of its components) provides the best fit to post-WWII data. These results are robust to various alternative specifications. We account for the COVID-19 period with a pandemic stringency index and for monetary policy shocks with a shadow interest rate. The government spending multiplier is approximately 0.5.

The Effects of Fiscal Policy When Planning Horizons are Finite

AbstractWe study the importance of planning horizons for fiscal multipliers in a New‐Keynesian model with bounded rationality. We show that, when agents have shorter planning horizons, government spending multipliers are smaller, whereas labor tax cut multipliers are larger. Furthermore, Ricardian equivalence breaks down, and transfer shocks feature a negative multiplier. Results are driven by the cognitive limitations of finite planning horizons that lead agent's expectations to deviate from the fully rational benchmark. We find larger investment responses, which are more in line with empirical findings than those of models with longer planning horizons, rule‐of‐thumb households, or a Blanchard–Yaari structure.

Does the Government Spending Multiplier Depend on the Business Cycle?

AbstractWe investigate the state dependency of the government spending multiplier across the business cycle using a nonlinear two‐regime VAR model. We find little evidence that multipliers vary between expansionary and recessionary periods. This is because the state of the business cycle itself changes after government spending shocks and converges toward a similar state. This result holds true regardless of how we model the business cycle. Our analysis shows that assumptions about the economic state built into linear impulse response functions are the key driver of the state dependency reported elsewhere in the literature.

Government spending multipliers with the Real Cost channel – ERRATUM

Government spending multipliers with the Real Cost channel – ERRATUM

Government spending multipliers with the Real Cost channel

AbstractIn the benchmark New Keynesian (NK) model, I introduce the real cost channel to study government spending multipliers and provide simple Markov chain closed-form solutions. This model departs fundamentally from most previous interpretations of the nominal cost channel by flattening the NK Phillips Curve in liquidity traps. At the zero lower bound, I show analytically that following positive government spending shocks, the real cost channel can make inflation rise less than in a model without this channel. This then causes a smaller drop in real interest rates, resulting in a lower output gap multiplier. Finally, I confirm the robustness of the real cost channel’s effect on multipliers using extensions of two models.

Italian local fiscal multipliers: Evidence from proxy-SVAR

In this letter, we use the Proxy-SVAR approach to investigate fiscal multipliers in Italy. We also estimate distinct multipliers for the Centre-North and the South. Our findings are consistent with the Keynesian view that advocates positive government spending multipliers and point at higher multipliers in the Centre-North.

Does it matter where and how governments spend?

This paper studies government spending multipliers in a panel of OECD countries. While recent literature has highlighted the differences in government consumption and investment effects, we extend this approach sectorally and report findings that suggest strong heterogeneities across sectors for government spending and output. Differences in price stickiness and sectors’ position in the production network are the main drivers of these heterogeneities.

Financial market imperfections, informality and government spending multipliers

Developing countries are characterized by underdeveloped financial markets and a large share of informal sector in economic activity. Evidence suggests that countries with less developed financial sector have lower government spending multipliers. This paper quantifies government spending multipliers in India using an estimated new-Keynesian DSGE model with two types of entrepreneurs: formal and informal and imperfect financial market. In the model, informal entrepreneurs are financially-excluded and the banking sector is monopolistically competitive featuring collateral constraint and sticky interest rates. Results show that the government consumption multiplier is significantly less than one at all horizons. The government investment multiplier is also significantly less than one at shorter horizons, but becomes approximately one at longer horizons.

Recovery of 1933

When Roosevelt abandoned the gold standard in April 1933, he converted government debt from a tax-backed claim to gold to a claim to dollars, opening the door to unbacked fiscal expansion. Roosevelt followed a state-contingent fiscal rule that ran nominal-debt-financed primary deficits until the price level rose and economic activity recovered. Theory suggests that government spending multipliers can be substantially larger when fiscal expansions are unbacked than when they are tax-backed. VAR estimates using data on "emergency" unbacked spending and "ordinary" backed spending confirm this prediction and find that primary deficits made quantitatively important contributions to raising both the price level and real GNP after 1933. VAR evidence does not support the conventional monetary explanation that gold revaluation and gold inflows, which raised the monetary base, drove the recovery independently of fiscal actions.

Do Government Spending Multipliers Depend on the Sign of the Shock?

We analyze whether government spending multipliers differ by the sign of the shock. Using aggregate historical US data, we apply Ben Zeev's (2020) nonlinear diagnostic tests and find evidence of nonlinearities in the impulse response functions of both government spending and GDP. We then extend Ramey and Zubairy's (2018) framework to allow for asymmetric effects as a type of state dependence to estimate multipliers. While we find differences in the impulse response functions, the resulting multipliers do not differ by sign of the shock. Thus, declines in government spending do not have different effects on economic activity than rises in spending.