Working Paper: CEPR ID: DP10353
Authors: Matthew Canzoneri; Fabrice Collard; Harris Dellas; Behzad Diba
Abstract: The Great Recession, and the fiscal response to it, has revived interest in the size of fiscal multipliers. Standard business cycle models have difficulties generating multipliers greater than one. And they also cannot produce any significant state-dependence in the size of the multipliers over the business cycle. In this paper we employ a variant of the Curdia-Woodford model of costly financial intermediation and show that fiscal multipliers can be strongly state dependent in a countercyclical manner. In particular, a fiscal expansion during a recession may lead to multiplier values exceeding two, while a similar expansion during an economic boom would produce multipliers falling short of unity. This pattern obtains if the spread (the financial friction) is more sensitive to fiscal policy during recessions than during expansions, a feature that is present in the data. Our results are consistent with recent empirical work documenting the state contingency of multipliers.
Keywords: Cyclicality; Financial Frictions; Government Spending Multipliers
JEL Codes: E32; E62; H3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscal expansion during a recession (E62) | Multiplier values exceeding two (C39) |
| Fiscal expansion during an economic boom (E62) | Multiplier values below one (C39) |
| Cyclical variation in bank intermediation costs (G21) | Stronger financial accelerator in recessions (E44) |
| Financial friction exacerbates during downturns (F65) | Inhibiting borrowing (H74) |
| Fiscal stimulus alleviates financial friction (E62) | Encouraging borrowing and spending (E62) |
| Larger fiscal interventions (E62) | Smaller multipliers due to negative wealth effects (E21) |
| Government spending financed through taxes (H59) | Multipliers remain greater than one (C39) |