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Fiscal Stimulus and Distortionary Taxation

  • Thorsten Drautzburg

    (University of Chicago)

  • Harald Uhlig

    (University of Chicago)

We quantify the size, uncertainty and sensitivity of fiscal multipliers in response to the American Recovery and Reinvestment Act (ARRA) of 2009. To that end, we extend the benchmark Smets- Wouters (Smets and Wouters, 2007) New Keynesian model, allowing for credit-constrained households, a central bank constrained by the zero lower bound, government capital and a government raising taxes with distortionary taxation. We distinguish between short-run and long-run multipliers. For a benchmark parameterization, we find modestly positive short-run multipliers with a posterior mean of 0.67 and modestly negative long-run multipliers centered around -0.21. The multiplier is particularly sensitive to the fraction of transfers given to credit-constrained households, is sensitive to the anticipated length of the zero lower bound, is sensitive to the capital share and is nonlinear in the degree of price and wage stickiness. Reasonable specifications are consistent with substantially negative short-run multipliers within a short time frame. Furthermore, monetary policy is remarkably powerful: increasing the zero lower bound from 8 to 12 quarters improves output far more than does the ARRA, without raising inflation. We interpret this to cast doubt on the ability of New Keynesian models to predict the effects of monetary policy.

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Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 481.

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Date of creation: 2011
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Handle: RePEc:red:sed011:481
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