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Spending Multipliers with Distortionary Taxes: Does the Level of Public Debt Matter?

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  • Rym Aloui

    (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824, F-69130 Ecully, France)

  • Aurélien Eyquem

    (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824, F-69130 Ecully, France ; Institut Universitaire de France)

Abstract

We investigate the link between the size of government indebtedness and the effectiveness of government spending shocks in normal times and at the Zero Lower Bound (ZLB). We develop a New Keynesian model with capital, distortionary taxes and public debt in which the ZLB constraint on the nominal interest rate may be binding. In normal times, high steady-state levels of government debt to GDP lead to reduced output multipliers. After a negative capital quality shock that pushes the economy at the ZLB however, high steadystate debt levels produce larger output multipliers. Our results rely on the fact that fiscal policy becomes self-financing at the ZLB, and that distortionary taxes rise (respectively fall) after a spending shock at the steady state (resp. ZLB). Our results have non-trivial consequences on the design of optimized spending policies in the event of large economic downturns.

Suggested Citation

  • Rym Aloui & Aurélien Eyquem, 2018. "Spending Multipliers with Distortionary Taxes: Does the Level of Public Debt Matter?," Working Papers 1831, Groupe d'Analyse et de Théorie Economique Lyon St-Étienne (GATE Lyon St-Étienne), Université de Lyon.
    • Handle: RePEc:gat:wpaper:1831
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    References listed on IDEAS

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    Cited by:

    1. Luca Metelli & Kevin Pallara, 2020. "Fiscal space and the size of the fiscal multiplier," Temi di discussione (Economic working papers) 1293, Bank of Italy, Economic Research and International Relations Area.
    2. Mindaugas Butkus & Diana Cibulskiene & Lina Garsviene & Janina Seputiene, 2021. "Empirical Evidence on Factors Conditioning the Turning Point of the Public Debt–Growth Relationship," Economies, MDPI, vol. 9(4), pages 1-22, December.
    3. Mindaugas Butkus & Diana Cibulskiene & Lina Garsviene & Janina Seputiene, 2021. "The Heterogeneous Public Debt–Growth Relationship: The Role of the Expenditure Multiplier," Sustainability, MDPI, vol. 13(9), pages 1-22, April.
    4. Thierry Betti & Thomas Coudert, 2022. "How harmful are cuts in public employment and wage in times of high unemployment?," Bulletin of Economic Research, Wiley Blackwell, vol. 74(1), pages 247-277, January.
    5. Ardanaz, Martín & Cavallo, Eduardo A. & Izquierdo, Alejandro & Puig, Jorge, 2021. "Output Effects of Fiscal Consolidations: Does Spending Composition Matter?," IDB Publications (Working Papers) 11857, Inter-American Development Bank.

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    More about this item

    Keywords

    Zero Lower Bound; Fiscal Policy; Distortionary Taxes; Public Debt;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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