Understanding the Size of the Government Spending Multiplier: It's in the Sign

Posted: 18 Dec 2017 Last revised: 7 Apr 2018

Date Written: 2017-12-15

Abstract

The literature on the government spending multiplier has implicitly assumed that an increase in government spending has the same (mirror-image) effect as a decrease in government spending. We show that relaxing this assumption is important to understand the effects of fiscal policy. 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 even larger 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.

Keywords: government spending

JEL Classification: C32, E62

Suggested Citation

Matthes, Christian, Understanding the Size of the Government Spending Multiplier: It's in the Sign (2017-12-15). FRB Richmond Working Paper No. 17-15. Available at SSRN: https://ssrn.com/abstract=3088997

Christian Matthes

Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

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