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Dissecting fiscal multipliers under the fiscal theory of the price level

Peder Beck-Friis and Tim Willems

European Economic Review, 2017, vol. 95, issue C, 62-83

Abstract: We derive analytical expressions for fiscal multipliers on output and inflation under the Fiscal Theory of the Price Level. In the associated ‘fiscal regime’, taxation multipliers turn positive, while the government spending multiplier has the same functional form as its counterpart in the ‘monetary regime’, augmented by a nominal wealth effect. As a result, fiscal multipliers tend to be larger in the fiscal regime, with the degree of price stickiness being a key determinant of their exact sizes. In particular, multipliers go to infinity as prices become fully fixed, and collapse to their equivalents in the monetary regime as prices become fully flexible. Standard calibrations suggest that the fiscal regime hosts a government spending multiplier on output that lies between 1 and 3. We also analyze the effectiveness of money-financed fiscal stimulus. In the fiscal regime, money-financed stimulus is equivalent to a particular form of debt-financed stimulus. The effectiveness of money-financed stimulus in raising output (relative to inflation) decreases as monetary policy becomes more responsive to inflation.

Keywords: Fiscal multiplier; Fiscal theory of the price level; Monetary financing; Inflation (search for similar items in EconPapers)
JEL-codes: E31 E52 E58 E62 E63 (search for similar items in EconPapers)
Date: 2017
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eecrev:v:95:y:2017:i:c:p:62-83

DOI: 10.1016/j.euroecorev.2017.03.006

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European Economic Review is currently edited by T.S. Eicher, A. Imrohoroglu, E. Leeper, J. Oechssler and M. Pesendorfer

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