Fiscal Multipliers under an Interest Rate Peg of Deterministic versus Stochastic Duration

Charles Carlstrom, Timothy Fuerst and Matthias Paustian

Journal of Money, Credit and Banking, 2014, vol. 46, issue 6, 1293-1312

Abstract: This paper revisits the size of the fiscal multiplier. The experiment is a fiscal expansion under the assumption of a pegged nominal rate of interest. We demonstrate that a quantitatively important issue is the articulation of the exit from the policy experiment. If the monetary‐fiscal expansion is stochastic with a mean duration of T periods, the fiscal multiplier can be unboundedly large. However, if the monetary‐fiscal expansion is for a fixed T periods, the multiplier is much smaller. Our explanation rests on a Jensen's inequality type argument: the deterministic multiplier is convex in duration, and the stochastic multiplier is a weighted average of the deterministic multipliers. The quantitative difference in the two multipliers also arises in a model with capital, and in the baseline nonlinear model. However, the differences between the two are less pronounced in the nonlinear models. The errors from a linear approximation are much larger for the stochastic exit model then for the deterministic exit model.

Date: 2014
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Persistent link: https://EconPapers.repec.org/RePEc:wly:jmoncb:v:46:y:2014:i:6:p:1293-1312

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