The Nonlinear Effects of Fiscal Policy

54 Pages Posted: 22 May 2019 Last revised: 1 Jun 2019

See all articles by Pedro Brinca

Pedro Brinca

Nova School of Business and Economics

Miguel Faria-e-Castro

Federal Reserve Bank of St. Louis

Miguel Homem Ferreira

Nova School of Business and Economics

Hans Holter

University of Oslo; Nova School of Business and Economics

Multiple version iconThere are 3 versions of this paper

Date Written: May, 2019

Abstract

We argue that the fiscal multiplier of government purchases in incomplete markets models is nonlinear in the spending shock, in contrast to the multiplier in complete markets models and what is assumed in most of the literature. In particular, the multiplier is increasing in the spending shock, with large positive shocks having the largest multiplier and large negative shocks having the smallest multiplier. The mechanism hinges on the relationship between fiscal shocks, their form of financing, and the response of labor supply across the wealth distribution. The model predicts that the aggregate labor supply elasticity is increasing in the fiscal shock, and this holds regardless of whether shocks are deficit- or balanced-budget financed. Our findings are consistent with aggregate fiscal consolidation data across 15 OECD countries over time. Furthermore, we find evidence of our mechanism in microdata for the US.

Keywords: Fiscal Multipliers, Nonlinearity, Asymmetry, Heterogeneous Agents

JEL Classification: E21, E62

Suggested Citation

Brinca, Pedro and Faria-e-Castro, Miguel and Homem Ferreira, Miguel and Holter, Hans, The Nonlinear Effects of Fiscal Policy (May, 2019). FRB St. Louis Working Paper No. 2019-15, Available at SSRN: https://ssrn.com/abstract=3392519 or http://dx.doi.org/10.20955/wp.2019.015

Pedro Brinca (Contact Author)

Nova School of Business and Economics ( email )

Campus de Carcavelos
Rua da Holanda, 1
Carcavelos, 2775-405
Portugal

HOME PAGE: http://htttp://www.pedrobrinca.pt

Miguel Faria-e-Castro

Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

Miguel Homem Ferreira

Nova School of Business and Economics ( email )

Campus de Carcavelos
Rua da Holanda, 1
Carcavelos, 2775-405
Portugal

Hans Holter

University of Oslo ( email )

PO Box 6706 St Olavs plass
Oslo, N-0317
Norway

Nova School of Business and Economics ( email )

Campus de Carcavelos
Rua da Holanda, 1
Carcavelos, 2775-405
Portugal

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