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.

Imperfect mobility of labor across sectors and fiscal transmission

“…These findings have also been further explored by who show in a panel of 17 OECD countries for the period 1975-2008 that fiscal multipliers are larger under fixed than under flexible exchange rates, lower when debt is high and larger during financial crises. A third noteworthy work is the paper by Brinca, Holter, Krusell, Malafry [2016] who show both empirically and theoretically that there is a strong positive relationship across countries between the magnitude of fiscal multipliers and wealth inequality captured by the Gini index.…”

“…Hours worked increase more on impact in recession though. Such an outcome could be the result of an increased fraction of poor non credit constrained agents who are at risk of hitting the constraint; according to the explanation put forward by Brinca et al [2016], these agents react to the negative wealth effect by increasing their labor supply substantially in order to avoid hitting the constraint. Third, inspection of results in the fifth row reveals that the responses of investment and the current account do not vary much across the state of the economy on impact.…”

“…In this regard, our study can be viewed as complementary to three papers which contrast the effects of fiscal policy on output across a number of country characteristics. In particular, Ilzetzki, Mendoza, and Vegh [2013] perform a split-sample analysis on the basis of the level of development, the level of public debt, trade openness, and exchange rate regimes, Born, Juessen and Müller [2013] further explore the implications of exchange rate regimes by investigating the role of anticipations, and Brinca et al [2016] document a strong positive relationship across countries between the magnitude of fiscal multipliers and wealth inequality. While these papers focus mainly on the aggregate fiscal multiplier, we explore the size of sectoral fiscal multipliers resulting from the reallocation of resources across sectors.…”

The income fluctuation problem and the evolution of wealth

“…The same study contains references on linkages between inequality and growth. Regarding fiscal policy, Brinca, Holter, Krusell, and Malafry (2016) find strong correlations between wealth inequality and the magnitude of fiscal multipliers, while Bhandari, Evans, Golosov, and Sargent (2018) study the connection between fiscal-monetary policy, business cycles and inequality. Ahn, Kaplan, Moll, Winberry, and Wolf (2018) discuss the impact of distributional properties on macroeconomic aggregates.…”

Detecting and Analyzing the Effects of Time‐varying Parameters in Dsge Models

“…For example, does a central bank react to inflation in the same way in an expansion as in a contraction (see Davig and Leeper, 2006)? Do fiscal multipliers depend on the level of inequality (see, e.g., Brinca et al, 2016)? Are households as risk averse when they are wealthy as when they are poor?…”