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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. Emi Nakamura & J?n Steinsson, 2014. "Fiscal Stimulus in a Monetary Union: Evidence from US Regions," American Economic Review, American Economic Association, vol. 104(3), pages 753-92, March.
  2. Gauti B. Eggertsson, 2009. "What fiscal policy is effective at zero interest rates?," Staff Reports 402, Federal Reserve Bank of New York.
  3. Christopher Pissarides, 2007. "The unemployment volatility puzzle: is wage stickiness the answer?," LSE Research Online Documents on Economics 4460, London School of Economics and Political Science, LSE Library.
  4. 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.
  5. Pontus Rendahl, 2014. "Fiscal Policy in an Unemployment Crisis," Discussion Papers 1405, Centre for Macroeconomics (CFM).
  6. Jonas D. M. Fisher & Ryan Peters, 2009. "Using stock returns to identify government spending shocks," Working Paper Series WP-09-03, Federal Reserve Bank of Chicago.
  7. Alessandro Barattieri & Susanto Basu & Peter Gottschalk, 2014. "Some Evidence on the Importance of Sticky Wages," American Economic Journal: Macroeconomics, American Economic Association, vol. 6(1), pages 70-101, January.
  8. 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.
  9. Alp Simsek & Anton Korinek, 2013. "Liquidity Trap and Excessive Leverage," 2013 Meeting Papers 1369, Society for Economic Dynamics.
  10. Florin Bilbiie, 2009. "Nonseparable Preferences, Fiscal Policy Puzzles, and Inferior Goods," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-00622869, HAL.
  11. Robert E. Hall, 2005. "Employment Fluctuations with Equilibrium Wage Stickiness," American Economic Review, American Economic Association, vol. 95(1), pages 50-65, March.
  12. 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.
  13. Barro, Robert J., 1974. "Are Government Bonds Net Wealth?," Scholarly Articles 3451399, Harvard University Department of Economics.
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