Fiscal multipliers in the 21st century

Abstract

The recent experience of a Great Recession has brought the effectiveness of fiscal policy back into focus. Fiscal multipliers do, however, vary greatly over time and place. Running VARs for a large number of countries, we document a strong correlation between wealth inequality and the magnitude of fiscal multipliers. To explain this finding, we develop a life-cycle, overlapping generations economy with uninsurable labor market risk. We calibrate our model to match key characteristics of a number of OECD economies, including the distribution of wages and wealth, social security, taxes and debt and study the effects of changing policies and various forms of inequality on the fiscal multiplier. We find that the fiscal multiplier is highly sensitive to the fraction of the population who face binding credit constraints and also negatively related to the average wealth level in the economy. This explains the correlation between wealth inequality and fiscal multipliers.

Fiscal Consolidation Programs and Income Inequality

“…Our model is a relatively standard life-cycle economy with heterogeneous agents and incomplete markets. It is similar to the model in Brinca et al (2016b), except that we have introduced a bequest motive to get a more realistic distribution of wealth over the life-cycle.…”

“…The key change compared to the steady state is that the dynamicprogramming problem of households need another state variable: time, t, capturing all the changes in policy and price variables relevant in this maximization problem. The numerical solution of the model necessitates guessing on paths for all the variables that will depend on time and then solving this maximization problem backward, after which the guess is updated; the method is similar to that used in Brinca et al (2016b) and Krusell and Smith (1999).…”

“…The parameter for the variance of ability, σ a , is assumed to be equal across countries and set equal to the average of σ a for the European countries in Brinca et al (2016b). Due to the lack of panel data on individual incomes for European economies, which we could use to estimate the persistence of the idiosyncratic shock ρ, we set it equal to the value used in Brinca et al (2016b), who use U.S. data from the Panel Study of Income Dynamics (PSID). The variance of the idiosyncratic income risk σ is then calibrated to make the model match the variance of log wages in the data.…”

“…To explain these empirical findings, we develop an overlapping generations economy with heterogeneous agents, exogenous credit constraints and uninsurable idiosyncratic risk, similar to that in Brinca et al (2016b). We calibrate the model to match data from a number of European countries along dimensions such as the distribution of income and wealth, taxes, social security and debt level.…”

Automatic stabilizers—the intersection of labour market and fiscal policies

“…Dolls et al (2012a) for empirical evidence and e.g. Corsetti and Müller (2015) and Brinca et al (2015) for theoretical analyses. 7 The metric here is from the OECD and often used in macro contexts.…”