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Budget Constrained Expenditure Multipliers

  • Ana-Isabel Guerra and Ferran Sancho

We show that 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. 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 upheld 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.

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Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 427.

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Date of creation: Sep 2015
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Handle: RePEc:bge:wpaper:427
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