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Credit Constraints and the Government Spending Multiplier

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  • Abo-Zaid, Salem
  • Kamara, Ahmed H.

Abstract

This paper studies the government spending multiplier in a quantitative model with credit constraints. We have four key results. First, credit constraints reduce the liquidity-trap government spending multiplier. This occurs partly because credit constraints weaken the “expected inflation channel” that has been central to large liquidity-trap spending multipliers in quantitative models. Second, this result holds even if the rise in government spending does not alter the tightness of the credit constraints. Third, the rise in government spending crowds out private borrowing, which leads to tighter credit constraints and even smaller spending multipliers. Fourth, with credit constraints, the liquidity-trap spending multiplier could be smaller than the spending multiplier during normal times.

Suggested Citation

  • Abo-Zaid, Salem & Kamara, Ahmed H., 2020. "Credit Constraints and the Government Spending Multiplier," Journal of Economic Dynamics and Control, Elsevier, vol. 116(C).
    • Handle: RePEc:eee:dyncon:v:116:y:2020:i:c:s0165188920300695
    DOI: 10.1016/j.jedc.2020.103901
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    More about this item

    Keywords

    Government spending multiplier; Credit constraints; Inflation; Liquidity trap;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
    • H50 - Public Economics - - National Government Expenditures and Related Policies - - - General

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