Hostname: page-component-78c5997874-m6dg7 Total loading time: 0 Render date: 2024-11-10T16:23:30.519Z Has data issue: false hasContentIssue false
  • English
  • Français

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

Published online by Cambridge University Press:  15 May 2018

Valerio Ercolani  and
João Valle e Azevedo
Valerio Ercolani
Affiliation:
Bank of Italy
João Valle e Azevedo*
Affiliation:
Bank of Portugal and Nova School of Business and Economics
*
Address correspondence to: João Valle e Azevedo, Bank of Portugal, Av. Almirante Reis 71, 6th Floor, 1150-012 Lisbon, Portugal. e-mail: azevedojv@gmail.com
Get access Rights & Permissions [Opens in a new window]

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.

Keywords

Nonseparable Government ConsumptionSubstitutabilityZero Lower BoundFiscal Multipliers
Type
Notes
Information
Macroeconomic Dynamics , Volume 23 , Issue 8 , December 2019 , pp. 3457 - 3482
Copyright
Copyright © Cambridge University Press 2018 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

The authors are grateful to Pedro Amaral, Rolando Bianchi, Ettore Panetti, and Pedro Teles for useful comments and suggestions. All errors are ours. The views expressed are those of the authors and do not necessarily represent those of Bank of Italy, Bank of Portugal, or the Eurosystem. Part of the work of Valerio Ercolani was carried out while he was working at Bank of Portugal.

References

REFERENCES

Ahmed, S. (1986) Temporary and permanent government spending in an open economy. Journal of Monetary Economics 17 (3), 197–224.Google Scholar
Albertini, J., Poirier, A. and Roulleau-Pasdeloup, J. (2014) The composition of government spending and the multiplier at the zero lower bound. Economics Letters 122 (1), 31–35.Google Scholar
Aiyagari, S., Christiano, L. and Eichenbaum, M. (1992) The output, employment, and interest rate effects of government consumption. Journal of Monetary Economics 30 (1), 73–86.10.1016/0304-3932(92)90045-4Google Scholar
Aruoba, S., Cuba-Borda, P., and Schorfheide, F. (2018) Macroeconomic dynamics near the ZLB: A tale of two countries. Review of Economic Studies 85 (1), 87–118.Google Scholar
Aschauer, D. A. (1985) Fiscal policy and aggregate demand. American Economic Review 75 (1), 117–127.Google Scholar
Auerbach, A. and Gorodnichenko, Y. (2012) Measuring the output responses to fiscal policy, American Economic Journal: Economic Policy 4 (2), 1–27.Google Scholar
Auerbach, A. and Gorodnichenko, Y. (2013) Output spillovers from fiscal policy. American Economic Review 103 (3), 141–46.Google Scholar
Barro, R. (1981) Output effects of government purchases. Journal of Political Economy 89 (6), 1086–1121.Google Scholar
Baxter, M. and King, R. (1993) Fiscal policy in general equilibrium. American Economic Review 83 (3), 315–334.Google Scholar
Bilbiie, F., Monacelli, T., and Perotti, R. (2017) Is Government Spending at the Zero Lower Bound Desirable? Mimeo, Bocconi University.Google Scholar
Bouakez, H. and Rebei, R. (2007) Why does private consumption rise after a government spending shock? Canadian Journal of Economics 40 (3), 954–979.Google Scholar
Bruckner, M. and Taludhar, A. (2014) Local government spending multipliers and financial distress: Evidence from Japanese prefectures. Economic Journal 124 (581), 1279–1313.Google Scholar
Christiano, L., Eichenbaum, M., and Rebelo, S. (2011) When is the government spending multiplier large? Journal of Political Economy 119 (1), 78–121.Google Scholar
Cogan, J. F., Cwik, T., Taylor, J. B., and Wieland, V. (2010) New Keynesian versus old Keynesian government spending multipliers. Journal of Economic Dynamic and Control 34 (3), 281–295.Google Scholar
Crafts, N. and Mills, T. C. (2013) Fiscal Policy in a Depressed Economy: Was There a ‘Free Lunch’ in 1930s' Britain? CEPR discussion papers 9273.Google Scholar
Drautzburg, T. and Uhlig, H. (2015) Fiscal stimulus and distortionary taxation. Review of Economic Dynamics 14 (4), 894–920.Google Scholar
Eggertsson, G. (2010) The Paradox of Toil. Mimeo, Federal Reserve Bank of New York.Google Scholar
Eggertsson, G. (2011) What fiscal policy is effective at zero interest rates? NBER Macroconomics Annual 2010 25, 59–112.10.1086/657529Google Scholar
Eggertsson, G., Mehrotra, N., and Robbins, J. A. (2017) A Model of Secular Stagnation: Theory and Quantitative Evaluation. NBER working papers 23093.Google Scholar
Eggertsson, G. and Woodford, M. (2003) The zero bound on interest rates and optimal monetary policy. Brookings Papers on Economic Activity 34 (1), 139–235.Google Scholar
Erceg, C. and Lindé, J. (2014) Is there a fiscal free lunch in a liquidity trap. Journal of the European Economic Association 12 (1), 73–107.Google Scholar
Ercolani, V. and Valle e Azevedo, J. (2014) The effects of public spending externalities. Journal of Economic Dynamics and Control 46, 173–199.Google Scholar
Ercolani, V. and Valle e Azevedo, J. (2017) Estimating the Relation in Preferences between Private and Government Consumption: The Role of Fiscal Rules. Mimeo, Banco de Portugal.Google Scholar
Evans, P. and Karras, G. (1998) Liquidity constraints and the substitutability between private and government consumption: The role of military and non-military spending. Economic Inquiry 36 (2), 203–214.Google Scholar
Feve, P., Matheron, J., and Sahuc, J. (2013) A pitfall with estimated DSGE-based government spending multipliers. American Economic Journal: Macroeconomics 5 (4), 141–178.Google Scholar
Galí, J., López-Salido, J. D. and Vallés, J. (2007) Understanding the effects of government spending on consumption. Journal of the European Economic Association 5 (1), 227–270.Google Scholar
Juillard, M. (1996) Dynare: A Program for the Resolution and Simulation of Dynamic Models with Forward Variables Through the Use of a Relaxation Algorithm. CEPREMAP working papers, 9602.Google Scholar
Karras, G. (1994) Government spending and private consumption: Some international evidence. Journal of Money, Credit and Banking 26 (1), 9–22.10.2307/2078031Google Scholar
Leeper, E. M., Plante, M., and Traum, N. (2010) Dynamics of fiscal financing in the United States. Journal of Econometrics 156 (2), 304–321.Google Scholar
Mertens, K. and Ravn, M. (2014) Fiscal policy in an expectations driven liquidity trap. Review of Economic Studies 81 (4), 1637–1667.Google Scholar
Miyamoto, W., Nguyen, T. L. and Sergeyev, D. (forthcoming) Government spending multipliers under the zero lower bound: Evidence from Japan. American Economic Journal: Macroeconomics.Google Scholar
Owyang, M. T., Ramey, V. and Zubairy, S. (2013) Are government spending multipliers greater during periods of slack? Evidence from twentieth-century historical data. American Economic Review 103 (3), 129–34.10.1257/aer.103.3.129Google Scholar
Ramey, V. (2011) Identifying government spending shocks: It's all in the timing. Quarterly Journal of Economics 126 (1), 1–50.Google Scholar
Ramey, V. and Zubairy, S. (2018) Government spending multipliers in good times and in bad: Evidence from U.S. historical data. Journal of Political Economy 126 (2), 850–901.Google Scholar
Schmitt-Grohé, S. and Uribe, M. (2006) Optimal fiscal and monetary policy in a medium-scale macroeconomic model. NBER Macroeconomics Annual 2005 20, 383–462.Google Scholar
Smets, F. and Wouters, R. (2007) Shocks and frictions in US business cycles: A Bayesian DSGE approach. American Economic Review 97 (3), 586–606.Google Scholar
Swanson, E. and John, C. Williams (2014) Measuring the effect of the zero lower bound on medium- and longer-term interest rates. American Economic Review 104 (10), 3154–3185.Google Scholar
Traum, N. and Yang, S. (2011) Monetary and fiscal policy interactions in the post-war U.S. European Economic Review 55 (1), 140–164.Google Scholar
Uhlig, H. (2010) Some fiscal calculus. American Economic Review 100 (2), 30–34.Google Scholar