The Nonlinear Effects of Fiscal Policy

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

See all articles by Pedro Brinca

Pedro Brinca

Nova School of Business and Economics; CEF.UP

Miguel Faria-e-Castro

Federal Reserve Bank of St. Louis

Miguel Homem Ferreira

Nova School of Business and Economics

Hans Holter

University of Oslo

Multiple version iconThere are 3 versions of this paper

Date Written: May 22, 2019

Abstract

We argue that the fiscal multiplier of government purchases is increasing in the spending shock, in contrast to what is assumed in most of the literature. The fiscal multiplier is largest for large positive government spending shocks and smallest for large contractions in government spending. We empirically document this fact using aggregate U.S. data. We find that a neoclassical, life-cycle, incomplete markets model calibrated to match key features of the US economy can explain this empirical finding. 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 size of the fiscal shock, and this holds regardless of whether shocks are deficit- or balanced-budget financed (albeit through different mechanisms). We find evidence of our mechanism in micro data 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 22, 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 Campolide
Lisbon, 1099-032
Portugal

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

CEF.UP ( email )

Rua Dr. Roberto Frias
Porto, 4200-464
Portugal

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 Campolide
Lisbon, 1099-032
Portugal

Hans Holter

University of Oslo ( email )

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

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