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The Nonlinear Effects of Fiscal Policy

Author

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  • Pedro Brinca

    (Universidade Nova de Lisboa)

  • Hans Holter

    (University of Oslo)

  • Miguel Faria-e-Castro

    (Federal Reserve Bank of St. Louis)

  • Miguel Ferreira

    (Nova SBE)

Abstract

We argue that the fiscal multiplier of government purchases is increasing in the shock, in contrast to what is assumed in most of the literature: the fiscal multiplier is largest for large positive government spending shocks and smallest for large contractions in government spending. We empirically document this fact by analyzing two independent datasets and using two different empirical approaches. We find that a neoclassical, life-cycle, incomplete markets model calibrated to match key features of the US economy, including the distribution of wealth, can well explain this empirical finding. The mechanism works through the relationship between fiscal shocks, the distribution of wealth and the aggregate labor supply elasticity: liquidity constrained agents have less elastic labor supply responses to changes in future income. An increase (decrease) in government spending today acts as a negative (positive) shock to future income, as future wages will be lower (higher). A large increase (decrease) in government spending today will induce saving (borrowing) and move a larger fraction of the agents in the economy away from (towards) the borrowing limit. Analysis of micro-data confirms the mechanism.

Suggested Citation

  • Pedro Brinca & Hans Holter & Miguel Faria-e-Castro & Miguel Ferreira, 2019. "The Nonlinear Effects of Fiscal Policy," 2019 Meeting Papers 934, Society for Economic Dynamics.
  • Handle: RePEc:red:sed019:934
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    References listed on IDEAS

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    Cited by:

    1. Brinca, Pedro & Duarte, João B. & Holter, Hans A. & Oliveira, João G., 2019. "Investment-Specific Technological Change, Taxation and Inequality in the U.S," MPRA Paper 91960, University Library of Munich, Germany.
    2. Fonseca, Miguel, 2020. "Fiscal Consolidations: Welfare Effects of the Adjustment Speed," MPRA Paper 98902, University Library of Munich, Germany, revised 02 Mar 2020.
    3. Nadav Ben Zeev, 2019. "Identification of Sign-Dependency of Impulse Responses," Working Papers 1907, Ben-Gurion University of the Negev, Department of Economics.
    4. Kopiec, Paweł, 2020. "Employment prospects and the propagation of fiscal stimulus," Journal of Economic Dynamics and Control, Elsevier, vol. 117(C).
    5. Bernardino, Tiago, 2019. "Asset Liquidity and Fiscal Consolidation Programs," MPRA Paper 93903, University Library of Munich, Germany.
    6. van der Wielen, Wouter, 2020. "The macroeconomic effects of tax changes: Evidence using real-time data for the European Union," Economic Modelling, Elsevier, vol. 90(C), pages 302-321.
    7. Tavares, Francisco, 2021. "Inflation heterogeneity and its impact on inequality: evidence from the United States," MPRA Paper 105461, University Library of Munich, Germany.
    8. Freitas, Bruno, 2020. "Labour Share Heterogeneity and Fiscal Consolidation Programs," MPRA Paper 98973, University Library of Munich, Germany.
    9. Nóbrega, Valter, 2020. "Optimal Taxation and Investment-Specific Technological Change," MPRA Paper 98917, University Library of Munich, Germany.
    10. De Dominicis, Piero, 2020. "Routinization and Covid-19: a comparison between United States and Portugal," MPRA Paper 101003, University Library of Munich, Germany.
    11. Zsurkis, Gabriel & Nicolau, João & Rodrigues, Paulo M. M, 2021. "The expected time to cross a threshold and its determinants: a simple and flexible framework," Journal of Economic Dynamics and Control, Elsevier, vol. 122(C).
    12. Ferrreira, Ana Melissa, 2019. "Skill-Biased Technological Change and Inequality in the U.S," MPRA Paper 93914, University Library of Munich, Germany.
    13. Faria-e-Castro, Miguel, 2021. "Fiscal policy during a pandemic," Journal of Economic Dynamics and Control, Elsevier, vol. 125(C).
    14. Santos, Mariana, 2020. "The impact of labor income tax progressivity on the fiscal multipliers in the context of fiscal consolidation programs," MPRA Paper 98736, University Library of Munich, Germany.

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    More about this item

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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