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The Nonlinear Effects of Fiscal Policy

Pedro Brinca (), Miguel Faria-e-Castro, Miguel Ferreira () and Hans Holter

No 2019-15, Working Papers from Federal Reserve Bank of St. Louis

Abstract: We argue that the fiscal multiplier of government purchases is increasing in the spending shock, in contrast to what is assumed in most of the literature. The fiscal multiplier is largest for large positive government spending shocks and smallest for large contractions in government spending. We empirically document this fact using aggregate U.S. data. We find that a neoclassical, life-cycle, incomplete markets model calibrated to match key features of the US economy can explain this empirical finding. The mechanism hinges on the relationship between fiscal shocks, their form of financing, and the response of labor supply across the wealth distribution. The model predicts that the aggregate labor supply elasticity is increasing in the size of the fiscal shock, and this holds regardless of whether shocks are deficit- or balanced-budget financed (albeit through different mechanisms). We find evidence of our mechanism in micro data for the US.

Keywords: Fiscal Multipliers; Nonlinearity; Asymmetry; Heterogeneous Agents (search for similar items in EconPapers)
JEL-codes: E21 E62 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge and nep-mac
Date: 2019-05-22
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DOI: 10.20955/wp.2019.015

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