The Fiscal Multiplier

73 Pages Posted: 19 Feb 2019

See all articles by Marcus Hagedorn

Marcus Hagedorn

University of Oslo - Department of Economics

Iourii Manovskii

University of Pennsylvania - Department of Economics; IZA Institute of Labor Economics

Kurt Mitman

IIES

Date Written: February 2019

Abstract

We measure the size of the fiscal multiplier using a heterogeneous-agent model with incomplete markets, capital and rigid prices and wages. The environment encompasses the essential elements necessary for a quantitative analysis of fiscal policy. First, output is partially demand-determined due to pricing frictions in product and labor markets, so that a fiscal stimulus increases aggregate demand. Second, incomplete markets deliver a realistic distribution of dynamic consumption and investment responses to stimulus policies across the population. These elements give rise to the standard textbook Keynesian-cross logic which, and unlike conventional wisdom would suggest, is significantly reinforced in our dynamic forward looking model.

We find that market incompleteness is key to determining the size of the fiscal multiplier, which is uniquely determined in our model for any combination of fiscal and monetary policies of interest. The multiplier is 1.34 if deficit-financed and 0.61 if contemporaneously tax-financed for a pegged nominal interest rate, with similar values in a liquidity trap. If monetary policy follows a Taylor rule, the numbers drop to 0.66 and 0.54, respectively. We elucidate the importance of market incompleteness for our results and contrast them to models featuring complete markets or hand-to-mouth consumers.

Keywords: Fiscal Multiplier, incomplete markets, liquidity trap, sticky prices

Suggested Citation

Hagedorn, Marcus and Manovskii, Iourii and Mitman, Kurt, The Fiscal Multiplier (February 2019). CEPR Discussion Paper No. DP13529. Available at SSRN: https://ssrn.com/abstract=3336787

Marcus Hagedorn (Contact Author)

University of Oslo - Department of Economics ( email )

P.O. Box 1095 Blindern
N-0317 Oslo
Norway

Iourii Manovskii

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-6880 (Phone)
215-573-2057 (Fax)

HOME PAGE: http://www.econ.upenn.edu/~manovski/

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Kurt Mitman

IIES ( email )

Stockholm, SE-10691
Sweden

HOME PAGE: http://kurtmitman.com

Register to save articles to
your library

Register

Paper statistics

Downloads
0
Abstract Views
101
PlumX Metrics