Government Spending between Active and Passive Monetary Policy

Theory suggests that the government spending multiplier is larger when monetary policy is passive. We find instead that, regardless of the monetary policy regime at the time of a spending shock, the central bank responds actively towards inflation quickly after the shock. This rapid monetary policy response leaves multipliers ultimately unaffected by whether the initial regime was active or passive. Our analysis highlights the necessity of accounting for the monetary policy reaction to spending shocks. Failure to do so ignores the central bank's ability to respond to shocks, potentially leading to a misrepresentation of how multipliers depend on monetary policy.