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Fiscal Policy in an Unemployment Crisis

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  • Rendahl, P.

Abstract

This 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 Info

Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 1211.

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Date of creation: 28 Feb 2012
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Handle: RePEc:cam:camdae:1211

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Web page: http://www.econ.cam.ac.uk/index.htm

Related research

Keywords: Fiscal multiplier; Fiscal policy; Liquidity trap; Unemployment inertia;

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  1. Alan J. Auerbach & Yuriy Gorodnichenko, 2010. "Measuring the Output Responses to Fiscal Policy," NBER Working Papers 16311, National Bureau of Economic Research, Inc.
  2. Alessandro Barattieri & Susanto Basu & Peter Gottschalk, 2010. "Some evidence on the importance of sticky wages," Working Papers 10-11, Federal Reserve Bank of Boston.
  3. Gauti B. Eggertsson, 2009. "What fiscal policy is effective at zero interest rates?," Staff Reports 402, Federal Reserve Bank of New York.
  4. Christopher A. Pissarides, 2007. "The Unemployment Volatility Puzzle: Is Wage Stickiness the Answer?," CEP Discussion Papers dp0839, Centre for Economic Performance, LSE.
  5. Emi Nakamura & Jón Steinsson, 2011. "Fiscal Stimulus in a Monetary Union: Evidence from U.S. Regions," NBER Working Papers 17391, National Bureau of Economic Research, Inc.
  6. Robert E. Hall, 2005. "Employment Fluctuations with Equilibrium Wage Stickiness," American Economic Review, American Economic Association, vol. 95(1), pages 50-65, March.
  7. Barro, Robert J., 1974. "Are Government Bonds Net Wealth?," Scholarly Articles 3451399, Harvard University Department of Economics.
  8. Jonas D. M. Fisher & Ryan Peters, 2009. "Using stock returns to identify government spending shocks," Working Paper Series WP-09-03, Federal Reserve Bank of Chicago.
  9. R. Anton Braun & Lena Mareen Körber & Yuichiro Waki, 2012. "Some unpleasant properties of log-linearized solutions when the nominal rate is zero," Working Paper 2012-05, Federal Reserve Bank of Atlanta.
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Cited by:
  1. Òscar Jordà & Alan M. Taylor, 2013. "The time for austerity: estimating the average treatment effect of fiscal policy," Working Paper Series 2013-25, Federal Reserve Bank of San Francisco.
  2. Jordan Roulleau-Pasdeloup, 2013. "The Productive Government Spending Multiplier, In and Out of The Zero Lower Bound," Working Papers 2013-02, Centre de Recherche en Economie et Statistique.
  3. Julien Albertini & Arthur Poirier, 2014. "Unemployment benefits extensions at the zero lower bound on nominal interest rate," SFB 649 Discussion Papers SFB649DP2014-019, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  4. Sebastian Gechert, 2013. "What fiscal policy is most effective? A Meta Regression Analysis," IMK Working Paper 117-2013, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.
  5. Zhen Huo & José-Víctor Ríos-Rull, 2013. "Engineering a paradox of thrift recession," CQER Working Paper 2013-03, Federal Reserve Bank of Atlanta.
  6. Zhen Huo & José-Víctor Ríos-Rull, 2013. "Paradox of Thrift Recessions," NBER Working Papers 19443, National Bureau of Economic Research, Inc.
  7. Spencer, Thomas & Lucas, Chancel & Emmanuel, Guerin, 2012. "Exiting the crisis in the right direction: A sustainable and shared prosperity plan for Europe," MPRA Paper 38802, University Library of Munich, Germany.

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