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The expected inflation channel of government spending in the postwar U.S

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  • Dupor, Bill
  • Li, Rong

Abstract

There exist sticky price models in which the output response to a government spending change can be large if the central bank is nonresponsive to inflation. According to this “expected inflation channel,” government spending drives up expected inflation, which in turn, reduces the real interest rate and leads to an increase in private consumption. This paper examines whether the channel was important in the post-WWII U.S., with particular attention to the 2009 Recovery Act period. First, we show that a model calibrated to have a large output multiplier requires a large response of expected inflation to a government spending shock. Next, we show that this large response is inconsistent with structural vector autoregression evidence from the Federal Reserve׳s passive policy period (1959–1979). Then, we study expected inflation measures during the Recovery Act period in conjunction with a panel of professional forecaster surveys, a cross-country comparison of bond yields and fiscal policy news announcements. We show that the expected inflation response was too small to engender a large output multiplier.

Suggested Citation

  • Dupor, Bill & Li, Rong, 2015. "The expected inflation channel of government spending in the postwar U.S," European Economic Review, Elsevier, vol. 74(C), pages 36-56.
  • Handle: RePEc:eee:eecrev:v:74:y:2015:i:c:p:36-56
    DOI: 10.1016/j.euroecorev.2014.11.004
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    More about this item

    Keywords

    Monetary policy; Fiscal policy; Output multipliers; 2009 Recovery Act;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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