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Understanding the size of the government spending multiplier: It’s in the sign

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Abstract
This paper argues that an important, yet overlooked, determinant of the government spending multiplier is the direction of the fiscal intervention. Regardless of whether we identify government spending shocks from (i) a narrative approach, or (ii) a timing restriction, we find that the contractionary multiplier - the multiplier associated with a negative shock to government spending - is above 1 and largest in times of economic slack. In contrast, the expansionary multiplier - the multiplier associated with a positive shock - is substantially below 1 regardless of the state of the cycle. These results help understand seemingly conflicting results in the literature. A simple theoretical model with incomplete financial markets and downward nominal wage rigidities can rationalize our findings.

Suggested Citation

  • Régis Barnichon & Davide Debortoli & Christian Matthes, 2019. "Understanding the size of the government spending multiplier: It’s in the sign," Economics Working Papers 1688, Department of Economics and Business, Universitat Pompeu Fabra, revised Sep 2020.
    • Handle: RePEc:upf:upfgen:1688
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    More about this item

    Keywords

    Public debt; optimal taxation; fiscal policy;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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