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Fiscal Policy in an Unemployment Crisis

  • Pontus Rendahl

    ()

    (University of Cambridge, Faculty of Economics
    Centre for Macroeconomics (CFM))

This paper shows that large fiscal multipliers arise naturally from equilibrium unemployment dynamics. In response to a shock that brings the economy into a liquidity trap, an expansion in government spending increases output and causes a fall in the unemployment rate. Since movements in unemployment are persistent, the effects of current spending linger into the future, leading to an enduring rise in income. As an enduring rise in income boosts private demand, even a temporary increase in government spending sets in motion a virtuous employment-spending spiral with a large associated multiplier. This transmission mechanism contrasts with the conventional view in which fiscal policy may be efficacious only under a prolonged and committed rise in government spending, which engineers a spiral of increasing infl ation.

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File URL: http://www.centreformacroeconomics.ac.uk/Discussion-Papers/2014/CFMDP2014-05-Paper.pdf
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Paper provided by Centre for Macroeconomics (CFM) in its series Discussion Papers with number 1405.

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Length: 37 pages
Date of creation: May 2014
Date of revision:
Handle: RePEc:cfm:wpaper:1405
Contact details of provider: Web page: http://www.centreformacroeconomics.ac.uk/

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  1. Daniel J. Wilson, 2012. "Fiscal Spending Jobs Multipliers: Evidence from the 2009 American Recovery and Reinvestment Act," American Economic Journal: Economic Policy, American Economic Association, vol. 4(3), pages 251-82, August.
  2. Ch. Pissarides., 2011. "The Unemployment Volatility Puzzle: Is Wage Stickiness the Answer?," VOPROSY ECONOMIKI, N.P. Redaktsiya zhurnala "Voprosy Economiki", vol. 1.
  3. Rendahl, P., 2012. "Fiscal Policy in an Unemployment Crisis," Cambridge Working Papers in Economics 1211, Faculty of Economics, University of Cambridge.
  4. Anton Korinek & Alp Simsek, 2014. "Liquidity Trap and Excessive Leverage," Koç University-TUSIAD Economic Research Forum Working Papers 1410, Koc University-TUSIAD Economic Research Forum.
  5. Barattieri, Alessandro & Basu, Susanto & Gottschalk, Peter T., 2010. "Some Evidence on the Importance of Sticky Wages," IZA Discussion Papers 5039, Institute for the Study of Labor (IZA).
  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. Alan J. Auerbach & Yuriy Gorodnichenko, 2012. "Measuring the Output Responses to Fiscal Policy," American Economic Journal: Economic Policy, American Economic Association, vol. 4(2), pages 1-27, May.
  8. JonasD.M. Fisher & Ryan Peters, 2010. "Using Stock Returns to Identify Government Spending Shocks," Economic Journal, Royal Economic Society, vol. 120(544), pages 414-436, 05.
  9. Gauti B. Eggertsson, 2009. "What fiscal policy is effective at zero interest rates?," Staff Reports 402, Federal Reserve Bank of New York.
  10. Barro, Robert J., 1974. "Are Government Bonds Net Wealth?," Scholarly Articles 3451399, Harvard University Department of Economics.
  11. 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.
  12. 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.
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