Working Paper: CEPR ID: DP7624
Authors: Christopher Erceg; Jesper Lind
Abstract: This paper uses a DSGE model to examine the effects of an expansion in government spending in a liquidity trap. The spending multiplier can be much larger than in the normal situation if the liquidity trap is very prolonged, and the budgetary costs minimal. But given this "fiscal free lunch," it is unclear why policymakers would want to limit the size of fiscal expansion. Our paper addresses this question in a model environment where the duration of the liquidity trap is determined endogenously, and depends on the size of the fiscal stimulus. We show that even if the multiplier is high for small increases in government spending, it may decrease substantially at higher spending levels; thus, it is crucial to distinguish between the average and marginal multiplier.
Keywords: DSGE model; fiscal policy; liquidity trap; monetary policy; zero bound constraint
JEL Codes: E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government spending during a liquidity trap (E62) | larger spending multiplier (E62) |
| higher levels of government spending (H59) | decrease in spending multiplier (E62) |
| liquidity trap (E41) | amplification of government spending multiplier (E62) |