Government Spending Effects in a Policy Constrained Environment

Ruoyun Mao and Shu-Chun Yang

No 2020/091, IMF Working Papers from International Monetary Fund

Abstract: The theoretical literature generally finds that government spending multipliers are bigger than unity in a low interest rate environment. Using a fully nonlinear New Keynesian model, we show that such big multipliers can decrease when 1) an initial debt-to-GDP ratio is higher, 2) tax burden is higher, 3) debt maturity is longer, and 4) monetary policy is more responsive to inflation. When monetary and fiscal policy regimes can switch, policy uncertainty also reduces spending multipliers. In particular, when higher inflation induces a rising probability to switch to a regime in which monetary policy actively controls inflation and fiscal policy raises future taxes to stabilize government debt, the multipliers can fall much below unity, especially with an initial high debt ratio. Our findings help reconcile the mixed empirical evidence on government spending effects with low interest rates.

Keywords: WP; nominal interest rate; regime F; government spending effects; fiscal multiplier; regime-switching policy; monetary; fiscal policy interaction; nonlinear New Keynesian models; government spending effect; output multiplier; government spending multiplier; government spending increase; fiscal policy; policy uncertainty; Inflation; Real interest rates; Consumption; Global; Zero lower bound (search for similar items in EconPapers)
Pages: 44
Date: 2020-06-12
New Economics Papers: this item is included in nep-dge and nep-mac
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Citations: View citations in EconPapers (3)

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