Budget-constrained expenditure multipliers
Standard expenditure multipliers capture economy-wide effects of new government projects only when financing constraints are not binding. In actual policy-making, however, new projects usually need financing. We show that under liquidity constraints, new projects are subject to two opposite effects: an income effect and a set of spending substitution effects. The former is the traditional, unrestricted, multiplier effect; the latter is the result of expenditure reallocation to uphold effective financing constraints. Unrestricted multipliers will therefore be, as a general rule, upward biased and policy designs based upon them should be reassessed in the light of the countervailing substitution effects. We also propose a novel decomposition of multiplier effects based on internal and external dependencies.
Volume (Year): 18 (2011)
Issue (Month): 13 ()
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