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The Nonlinear Effects of Fiscal Policy

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

No 2019-015, Working Papers from Federal Reserve Bank of St. Louis

Abstract: We argue that the fiscal multiplier of government purchases in incomplete markets models is nonlinear in the spending shock, in contrast to the multiplier in complete markets models and what is assumed in most of the literature. In particular, the multiplier is increasing in the spending shock, with large positive shocks having the largest multiplier and large negative shocks having the smallest multiplier. 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 fiscal shock, and this holds regardless of whether shocks are deficit- or balanced-budget financed. Our findings are consistent with aggregate fiscal consolidation data across 15 OECD countries over time. Furthermore, we find evidence of our mechanism in microdata 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)
Pages: 53 pages
Date: 2019-05-22, Revised 2022-02-17
New Economics Papers: this item is included in nep-dge and nep-mac
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DOI: 10.20955/wp.2019.015

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