The Sectoral Origins of the Spending Multiplier

Abstract

The aggregate spending multiplier crucially depends on the sectoral origin of government purchases. To establish this result, we characterize analytically the response of aggregate output to sector-specific government spending shocks in a tractable production-network economy, showing how it maps into various characteristics of the shocked sector. The response is larger when government spending originates in sectors with a relatively small contribution to private final demand, low markup, high labor intensity, and in those located downstream in the supply chain. We confirm these predictions and evaluate their quantitative relevance within a calibrated multi-sector model of the U.S. economy that embeds several dimensions of sectoral heterogeneity. We also providesupporting empirical evidence by exploiting heterogeneity in the sectoral composition of military spending across U.S. states. Based on the calibrated model, we document significant dispersion in the aggregate spending multiplier associated with sectoral government purchases. Finally, we illustrate how differences in the sectoral composition of purchases across U.S. government levels lead to large variation in the spending multiplier. The latter ranges from 0.47 for federal defense spending, which is mainly concentrated in manufacturing, to 0.82 for state & local spending, which is mostly oriented towards services.

Keywords: Government Spending Multiplier, Production Network, Relative Prices, Sectoral Heterogeneity, Sector-Specic Shocks.