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Downward nominal wage rigidity and state-dependent government spending multipliers

Wenyi Shen () and Shu-Chun S. Yang

Journal of Monetary Economics, 2018, vol. 98, issue C, 11-26

Abstract: Despite much empirical evidence on business cycle-dependent government spending multipliers, the theoretical channels underlying such results are uncertain. In an environment with involuntary unemployment, this paper shows that downward nominal wage rigidity, which arises only in recessions, can generate business cycle-dependent government spending multipliers. In line with Keynesian views, a demand stimulus reduces unemployment in recessions and may not drive up inflation and wages as in expansions. Thus, the positive income effects from reduced unemployment and weaker crowding-out effects from a smaller increase in the real interest rate enhance the expansionary spending effects in recessions. The theoretical implications are largely consistent with existing empirical evidence on business cycle-dependent government spending effects on key macroeconomic variables.

Keywords: Business cycle-dependent multiplier; State dependent government spending effects; Downward nominal wage rigidity; Fiscal policy effects; New Keynesian models (search for similar items in EconPapers)
JEL-codes: E31 E62 H30 (search for similar items in EconPapers)
Date: 2018
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Handle: RePEc:eee:moneco:v:98:y:2018:i:c:p:11-26