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Dissecting fiscal multipliers under the fiscal theory of the price level

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  • Beck-Friis, Peder
  • Willems, Tim

Abstract

We derive analytical expressions for fiscal multipliers on output and inflation under the Fiscal Theory of the Price Level. In the associated ‘fiscal regime’, taxation multipliers turn positive, while the government spending multiplier has the same functional form as its counterpart in the ‘monetary regime’, augmented by a nominal wealth effect. As a result, fiscal multipliers tend to be larger in the fiscal regime, with the degree of price stickiness being a key determinant of their exact sizes. In particular, multipliers go to infinity as prices become fully fixed, and collapse to their equivalents in the monetary regime as prices become fully flexible. Standard calibrations suggest that the fiscal regime hosts a government spending multiplier on output that lies between 1 and 3. We also analyze the effectiveness of money-financed fiscal stimulus. In the fiscal regime, money-financed stimulus is equivalent to a particular form of debt-financed stimulus. The effectiveness of money-financed stimulus in raising output (relative to inflation) decreases as monetary policy becomes more responsive to inflation.

Suggested Citation

  • Beck-Friis, Peder & Willems, Tim, 2017. "Dissecting fiscal multipliers under the fiscal theory of the price level," European Economic Review, Elsevier, vol. 95(C), pages 62-83.
    • Handle: RePEc:eee:eecrev:v:95:y:2017:i:c:p:62-83
    DOI: 10.1016/j.euroecorev.2017.03.006
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    References listed on IDEAS

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    Keywords

    Fiscal multiplier; Fiscal theory of the price level; Monetary financing; Inflation;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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