State dependent government spending multipliers: Downward nominal wage rigidity and sources of business cycle fluctuations

Yoon Jo () and Sarah Zubairy

No 20210127-001, Working Papers from Texas A&M University, Department of Economics

Abstract: This paper shows that the source of business cycle fluctuations matters for determining the size of government spending multipliers. We present a New Keynesian model with downward nominal wage rigidity (DNWR) and show that government spending is much more effective in stimulating output in a demand shock driven recession compared to a supply shock driven recession. Government spending multiplier is large when DNWR binds in a recession, but the nature of recession matters due to the opposing responses of inflation depending on the type of recession. In a demand-driven recession, inflation falls, preventing real wages from falling, leading to consequences for employment, while inflation rises in a supply-driven recession limiting the consequences of DNWR on employment. We document supporting empirical evidence, using both historical time series data and cross-sectional data from U.S. states, that the government spending multiplier for output is larger in a demand-driven recession compared to a supply-driven recession.

Keywords: Government Spending Multipliers; Source of Fluctuation; Downward Nominal Wage Rigidity. (search for similar items in EconPapers)
JEL-codes: E24 E32 E62 (search for similar items in EconPapers)
Pages: 59 pages
Date: 2021-01-27
New Economics Papers: this item is included in nep-dge, nep-lma, nep-mac and nep-ore
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (13)

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Related works:
Journal Article: State-Dependent Government Spending Multipliers: Downward Nominal Wage Rigidity and Sources of Business Cycle Fluctuations (2025)
Working Paper: State Dependent Government Spending Multipliers: Downward Nominal Wage Rigidity and Sources of Business Cycle Fluctuations (2022)
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