Government Spending Effects in a Policy Constrained Environment

45 Pages Posted: 23 Jul 2020

See all articles by Ruoyun Mao

Ruoyun Mao

Indiana University

Shu-Chun Susan Yang

International Monetary Fund (IMF)

Date Written: June 1, 2020


The theoretical literature generally finds that government spending multipliers are bigger than unity in a low interest rate environment. Using a fully nonlinear New Keynesian model, we show that such big multipliers can decrease when 1) an initial debt-to-GDP ratio is higher, 2) tax burden is higher, 3) debt maturity is longer, and 4) monetary policy is more responsive to inflation. When monetary and fiscal policy regimes can switch, policy uncertainty also reduces spending multipliers. In particular, when higher inflation induces a rising probability to switch to a regime in which monetary policy actively controls inflation and fiscal policy raises future taxes to stabilize government debt, the multipliers can fall much below unity, especially with an initial high debt ratio. Our findings help reconcile the mixed empirical evidence on government spending effects with low interest rates.

JEL Classification: E32, E52, E62, E63, H30, E01, G21, K34, E31

Suggested Citation

Mao, Ruoyun and Yang, Shu-Chun Susan, Government Spending Effects in a Policy Constrained Environment (June 1, 2020). IMF Working Paper No. 20/91, Available at SSRN:

Ruoyun Mao (Contact Author)

Indiana University ( email )

107 S Indiana Ave
100 South Woodlawn
Bloomington, IN 47405
United States

Shu-Chun Susan Yang

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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