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Fiscal Multipliers and Policy Coordination

  • Gauti B. Eggertsson

This paper analyzes the effectiveness of fiscal policy at zero nominal interest rates. I solve a stochastic general equilibrium model with sticky prices assuming that the government cannot commit to future policy. Real government spending increases demand by boosting public consumption. Deficit spending increases demand by generating inflation expectations. I compute multipliers of government spending that calculate by how much each dollar of spending increases output. Both the deficit and the real spending multipliers can be large, but the multiplier of deficit spending depends critically on monetary and fiscal cooperation: it can be large with cooperation and zero without it. The theory suggests one interesting interpretation of why recovery measures–such as fiscal spending, exchange interventions, and large increases in the money supply–had a smaller effect on nominal demand in Japan during the Great Recession (1992-2006) than during the US's Great Depression (1929-1941). In both episodes, the short-term nominal interest rate was close to zero. The theory suggests that part of the difference can be explained by the fact that, while monetary and fiscal policy were coordinated in the US during the Great Depression, they were not in Japan during the Great Recession. The overall conclusion of the paper is that the effect of given policy actions depends crucially on the institutional setup in the economy.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 628.

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Date of creation: May 2011
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Handle: RePEc:chb:bcchwp:628
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