The Nonlinear Effects of Fiscal Policy

Posted: 16 Jun 2020 Last revised: 18 Feb 2022

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 Aasnes Holter

University of Delaware - Economics; University of Oslo - Department of Economics; Nova School of Business and Economics

Multiple version iconThere are 3 versions of this paper

Date Written: May 22, 2020

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 Aasnes, The Nonlinear Effects of Fiscal Policy (May 22, 2020). Available at SSRN: https://ssrn.com/abstract=3608015 or http://dx.doi.org/10.2139/ssrn.3608015

Pedro Brinca

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 Aasnes Holter (Contact Author)

University of Delaware - Economics ( email )

Newark, DE 19716
United States

University of Oslo - Department of Economics ( email )

P.O. Box 1095 Blindern
N-0317 Oslo
Norway
+47-22855108 (Phone)

HOME PAGE: http://sites.google.com/site/hansaholter/

Nova School of Business and Economics ( email )

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

Do you have negative results from your research you’d like to share?

Paper statistics

Abstract Views
379
PlumX Metrics