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Should We Use Linearised Models to Calculate Fiscal Multipliers?

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  • Jesper Lindé
  • Mathias Trabandt

Abstract

We calculate the magnitude of the fiscal spending multiplier in linearised and nonlinear solutions of a New Keynesian model at the zero lower bound. Importantly, the model is amended with real rigidities to simultaneously account for the macroeconomic evidence of a low Phillips curve slope and the microeconomic evidence of frequent price re-optimisation. We show that the nonlinear solution is associated with a much smaller multiplier than the linearised solution in long-lived liquidity traps, and pin down the key features in the model which account for the difference. Our results caution against the common practice of using linearised models to calculate fiscal multipliers in long-lived liquidity traps.

Suggested Citation

  • Jesper Lindé & Mathias Trabandt, 2017. "Should We Use Linearised Models to Calculate Fiscal Multipliers?," European Economy - Discussion Papers 2015 - 064, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission.
  • Handle: RePEc:euf:dispap:064
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    References listed on IDEAS

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    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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