Deconstructing the Fiscal Multiplier

Using expectation data from the Survey of Professional Forecasters (SPF) we decompose the impact of government spending on output into three distinct and theoretically grounded channels: the Keynesian channel, linking current income to current private expenditures; the expected-inflation channel which stresses the need to engineer an inflationary spiral in order to reduces real interest rates; and the expected-output channel in which the persistence of output propagates the effect of current spending by altering expectations of future economic activity. Our findings reveal that the expected-output channel accounts for about 35% of the total impact of government spending on output, while the expected output channel is statistically insignificant with a point estimate of around 7%. While the expected-inflation channel seemingly gain some support by the data, the associated theoretical transmission mechanism is heavily put into question: The effect of expected future inflation on output is negative, and a rise in government spending is associated with a decrease in inflation. This contrasts sharply to the theoretical literature in which expected inflation affect output positively, and a rise in government spending is associated with an increase in inflation.