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The Expected Inflation Channel of Government Spending in the Postwar U.S

  • Dupor, William

    (Federal Reserve Bank of St. Louis)

  • Li, Rong

    (The Ohio State University and Renmin University)

There exist sticky price models in which the output response to a government spending change can be large if the central bank is nonresponsive to inflation. According to this “expected inflation channel," government spending drives up expected inflation, which in turn, reduces the real interest rate and leads to an increase in private consumption. This paper examines whether the channel was important in the post-WWII U.S., with particular attention to the 2009 Recovery Act period. First, we show that a model calibrated to have a large output multiplier requires a large response of expected inflation to a government spending shock. Next, we show that this large response is inconsistent with structural vector autoregression evidence from the Federal Reserve's passive policy period (1959-1979). Then, we study expected inflation measures during the Recovery Act period in conjunction with a panel of professional forecaster surveys, a cross-country comparison of bond yields and fiscal policy news announcements. We show that the expected inflation response was too small to engender a large output multiplier.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2013-026.

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Length: 39 pages
Date of creation: 2013
Date of revision: 12 May 2014
Handle: RePEc:fip:fedlwp:2013-026
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  18. Valerie A. Ramey, 2011. "Identifying Government Spending Shocks: It's all in the Timing," The Quarterly Journal of Economics, Oxford University Press, vol. 126(1), pages 1-50.
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