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Fiscal Multipliers and Policy Coordination

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  • Gauti B. Eggertsson

Abstract

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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  • Gauti B. Eggertsson, 2011. "Fiscal Multipliers and Policy Coordination," Working Papers Central Bank of Chile 628, Central Bank of Chile.
  • Handle: RePEc:chb:bcchwp:628
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    Cited by:

    1. Philip Arestis, 2011. "Fiscal Policy Is Still an Effective Instrument of Macroeconomic Policy," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 58(2), pages 143-156, June.
    2. Matthew Denes & Gauti B. Eggertsson, 2009. "A Bayesian approach to estimating tax and spending multipliers," Staff Reports 403, Federal Reserve Bank of New York.
    3. Maria Kazakova & Alexandr Knobel & Ilya Sokolov, 2010. "Quality of VAT administration in OECD countries and Russia. Reform of the Russian system of tax collection," Research Paper Series, Gaidar Institute for Economic Policy, issue 134P.
    4. Alan J. Auerbach & William G. Gale, 2009. "Activist fiscal policy to stabilize economic activity," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 327-374.

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