Working Paper: NBER ID: w30025
Authors: Yoon J. Jo; Sarah Zubairy
Abstract: We consider a New Keynesian model with downward nominal wage rigidity (DNWR) and show that government spending is much more effective in stimulating output in a low-inflation recession relative to a high-inflation recession. The government spending multiplier is large when DNWR binds, but the nature of recession matters due to the opposing response of inflation. In a demand-driven recession, inflation falls, preventing real wages from falling, leading to unemployment, while inflation rises in a supply-driven recession limiting the consequences of DNWR on employment. We document supporting empirical evidence, using both historical time series data and cross-sectional data from U.S. states.
Keywords: government spending; multipliers; downward nominal wage rigidity; business cycle fluctuations
JEL Codes: E24; E32; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government spending (H59) | Economic output (E23) |
| Government spending (H59) | Economic output (in low inflation, high unemployment) (E23) |
| Government spending (H59) | Economic output (in high inflation) (E31) |
| Low inflation and high unemployment (E31) | Larger government spending multiplier (E62) |
| High inflation (E31) | Smaller government spending multiplier (E62) |
| Demand-driven recession (E32) | Larger government spending multiplier (E62) |
| Supply-driven recession (E65) | Smaller government spending multiplier (E62) |