Fiscal Policy in an Unemployment Crisis
AbstractThis paper argues that the effectiveness of fiscal policy may increase markedly during periods of low nominal interest rates and high, persistent, unemployment. An increase in government spending boosts economic activity and reduces the unemployment rate both in the present and in the future. As a less disconcerting future spurs a rise in private consumption, unemployment falls even further and triggers an additional rise in private demand, and so on. In a stylized model, I show that the marginal impact of government spending on output is equal to the reciprocal of the elasticity of intertemporal substitution. In a more realistic framework, the effect is somewhat attenuated and displays significant nonlinearities with respect to the depth of the crisis as well as the size of the stimulus package. But in a severe recession with an unemployment rate of eight percent or above, the fiscal multiplier is equal to 1.5.
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Bibliographic InfoPaper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 1211.
Date of creation: 28 Feb 2012
Date of revision:
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Web page: http://www.econ.cam.ac.uk/index.htm
Fiscal multiplier; Fiscal policy; Liquidity trap; Unemployment inertia;
Find related papers by JEL classification:
- E24 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution
- E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
- H12 - Public Economics - - Structure and Scope of Government - - - Crisis Management
- H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
- J23 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Labor Demand
- J64 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Unemployment: Models, Duration, Incidence, and Job Search
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-03-08 (All new papers)
- NEP-MAC-2012-03-08 (Macroeconomics)
- NEP-PKE-2012-03-08 (Post Keynesian Economics)
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