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Spending multipliers with distortionary taxes: Does the level of public debt matter?

Rym Aloui and Aurélien Eyquem

Journal of Macroeconomics, 2019, vol. 60, issue C, 275-293

Abstract: We investigate the link between the size of government indebtedness and the effectiveness of government spending shocks in normal times and at the Zero Lower Bound (ZLB). We develop a New Keynesian model with capital, distortionary taxes and public debt in which the ZLB constraint on the nominal interest rate may be binding. In normal times, high steady-state levels of government debt to GDP lead to reduced output multipliers. After a negative capital quality shock that pushes the economy at the ZLB however, high steady-state debt levels produce larger output multipliers. Our results rely on the fact that fiscal policy becomes self-financing at the ZLB, and that distortionary taxes rise (respectively fall) after a spending shock at the steady state (resp. ZLB). Our results have non-trivial consequences on the design of optimized spending policies in the event of large economic downturns.

Keywords: Zero lower bound; Fiscal policy; Distortionary taxes; Public debt (search for similar items in EconPapers)
JEL-codes: E62 E32 (search for similar items in EconPapers)
Date: 2019
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Related works:
Working Paper: Spending multipliers with distortionary taxes: Does the level of public debt matter? (2019)
Working Paper: Spending Multipliers with Distortionary Taxes: Does the Level of Public Debt Matter? (2018) Downloads
Working Paper: Spending Multipliers with Distortionary Taxes: Does the Level of Public Debt Matter? (2018) Downloads
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