Hostname: page-component-78c5997874-mlc7c Total loading time: 0 Render date: 2024-11-13T22:48:48.656Z Has data issue: false hasContentIssue false
  • English
  • Français

THE GOVERNMENT SPENDING MULTIPLIER IN A MODEL WITH THE COST CHANNEL

Published online by Cambridge University Press:  14 April 2020

Salem Abo-Zaid
Salem Abo-Zaid*
Affiliation:
University of Maryland-Baltimore County
*
Address correspondence to: Salem Abo-Zaid, Department of Economics, University of Maryland-Baltimore County, 1000 Hilltop Circle, Baltimore, MD21250, USA. e-mail: [email protected]. Phone: (410)-455-2498. Fax: (410)-455-1054.
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper studies the government spending multiplier in the presence of the cost channel of the nominal interest rate. I find that the spending multiplier of normal times declines markedly when this channel is introduced. The rise in government spending leads to a rise in the nominal interest rate and, with the cost channel, to a rise in the marginal cost and inflation. In turn, this leads to a bigger rise in the nominal interest rate and the expected real interest rate, hence a lower multiplier, than in a model that abstracts from the cost channel. On the other hand, in a liquidity trap, the cost channel makes the spending multiplier larger. Therefore, by ignoring the cost channel, the spending multiplier is overestimated in normal times and underestimated during liquidity trap episodes. Since liquidity traps are rare, however, the spending multiplier is mostly lower than in previous estimates.

Keywords

Government Spending MultiplierCost ChannelFiscal PolicyMonetary Policy
Type
Articles
Information
Macroeconomic Dynamics , Volume 26 , Issue 1 , January 2022 , pp. 72 - 101
Copyright
© Cambridge University Press 2020

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

I am grateful to William A. Barnett (the editor), the associate editor and two anonymous referees for very invaluable comments and suggestions.

References

REFERENCES

Arin, K. P., Koray, F. and Spagnolo, N. (2015) Fiscal multipliers in good times and bad times. Journal of Macroeconomics 44, 303–311.CrossRefGoogle Scholar
Auerbach, A. J. and Gorodnichenko, Y. (2012) Measuring the output responses to fiscal policy. American Economic Journal: Economic Policy 4, 1–27.Google Scholar
Barth, M. J. and Ramey, V. A. (2001) The cost channel of monetary transmission. NBER Macroeconomics Annual 16, 199–256.CrossRefGoogle Scholar
Blanchard, O. and Perotti, R. (2002) An empirical characterization of the dynamic effects of changes in government spending and taxes on output. Quarterly Journal of Economics 117, 1329–1368.CrossRefGoogle Scholar
Bouakez, H., Guillard, M. and Roulleau-Pasdeloup, J. (2017) Public investment, time to build, and the zero lower bound. Review of Economic Dynamics 23, 60–79.CrossRefGoogle Scholar
Caggiano, G., Castelnuovo, E., Colombo, V. and Nodari, G. (2015) Estimating fiscal multipliers: News from a non-linear world. Economic Journal 125, 746–776.CrossRefGoogle Scholar
Calvo, G. A. (1983) Staggered prices in a utility-maximizing framework. Journal of Monetary Economics 12, 383–398.CrossRefGoogle Scholar
Carlstrom, C. T. and Fuerst, T. S. (1997) Agency costs, net worth, and business fluctuations: A computable general equilibrium analysis. American Economic Review 87, 893–910.Google Scholar
Carlstrom, C. T., Fuerst, T. S. and Paustian, M. (2014) Fiscal multipliers under an interest rate peg of deterministic versus stochastic duration. Journal of Money, Credit and Banking 46, 37–70.CrossRefGoogle Scholar
Chowdhury, I., Hoffmann, M. and Schabert, A. (2006) Inflation dynamics and the cost channel of monetary transmission. European Economic Review 50, 995–1016.CrossRefGoogle Scholar
Christiano, L. J., Eichenbaum, M. and Evans, C. L. (2005) Nominal rigidities and the dynamic effects of shock to monetary policy. Journal of Political Economy 113, 1–45.CrossRefGoogle Scholar
Christiano, L. J., Eichenbaum, M. and Rebelo, S. (2011) When is the government spending multiplier large? Journal of Political Economy 119, 78–121.CrossRefGoogle Scholar
Dupor, B. and Li, R. (2015) The expected inflation channel of government spending in the postwar U.S. European Economic Review 74, 36–56.CrossRefGoogle Scholar
Elyasiani, E., Kopecky, K. J. and VanHoose, D. D. (1995) Costs of adjustment, portfolio separation, and the dynamic behavior of bank loans and deposits. Journal of Money, Credit and Banking 27, 955–974.CrossRefGoogle Scholar
Ercolani, V. and e Azevedo, J. V., (2019) How can the government spending multiplier be small at the zero lower bound? Macroeconomic Dynamics 23, 3457–3482.CrossRefGoogle Scholar
Fisher, J. D. M. and Peters, R. (2010) Using stock returns to identify government spending shocks. Economic Journal 120, 414–436.CrossRefGoogle Scholar
Flotho, S. (2015) Fiscal multipliers in a monetary union under the zero-lower-bound constraint. Macroeconomic Dynamics 19, 1171–1194.CrossRefGoogle Scholar
Freixas, X. and Rochet, J.-C. (1997) Microeconomics of Banking. Cambridge, MA: The MIT Press.Google Scholar
Gaiotti, E. and Secchi, A. (2006) Is there a cost channel of monetary policy transmission? An investigation into the pricing behavior of 2,000 firms. Journal of Money, Credit and Banking 38, 2013–2037.CrossRefGoogle Scholar
Gerali, A., Neri, S., Sessa, L. and Signoretti, F. (2010) Credit and banking in a DSGE model of the Euro area. Journal of Money, Credit and Banking 42(s1), 107–141.CrossRefGoogle Scholar
Gertler, M. and Karadi, P. (2015) Monetary policy surprises, credit costs, and economic activity. American Economic Journal: Macroeconomics 7, 44–76.Google Scholar
Gilchrist, S. and Zakrajek, E. (2012) Credit spreads and business cycle fluctuations. American Economic Review 102, 1692–1720.CrossRefGoogle Scholar
Ilzetzki, E., Mendoza, E. G. and Vegh, C. A. (2013) How big (small?) are fiscal multipliers? Journal of Monetary Economics 60, 239–254.CrossRefGoogle Scholar
Jorda, O. (2005) Estimation and inference of impulse responses by local projections. American Economic Review 95, 161–182.CrossRefGoogle Scholar
Kopecky, K. and VanHoose, D. D. (2012) Imperfect competition in bank retail markets, deposit and loan rate dynamics, and incomplete pass through. Journal of Money, Credit and Banking 44, 1185–1205.CrossRefGoogle Scholar
Leeper, E. M., Traum, N. and Walker, T. B. (2017) Clearing up the fiscal multiplier morass. American Economic Review 107, 2409–2454.CrossRefGoogle Scholar
McCallum, B. T. (1983) On non-uniqueness in rational expectations models: An attempt at perspective. Journal of Monetary Economics 11, 139–168.CrossRefGoogle Scholar
McCallum, B. T. (1999) Role of the minimal state variable criterion in rational expectations models. International Tax and Public Finance 6, 621–639.CrossRefGoogle Scholar
Mitra, K., Evans, G. W. and Honkapohja, S. (2019) Fiscal policy multipliers in an RBC model with learning. Macroeconomic Dynamics 23, 240–283.CrossRefGoogle Scholar
Ngo, P. V. (in press) Fiscal multipliers at the zero lower bound: The role of government spending persistence. Macroeconomic Dynamics.Google Scholar
Quaghebeur, E. (2019) Learning and the size of the government spending multiplier. Macroeconomic Dynamics 23, 3189–3224.CrossRefGoogle Scholar
Ramey, V. A. (2011) Identifying government spending shocks: It’s all in the timing. Quarterly Journal of Economics 126, 1–50.CrossRefGoogle Scholar
Ramey, V. A. (2016) Macroeconomic shocks and their propagation. In: Taylor, J. B. and Uhlig, H. (eds.), Handbook of Macroeconomics, vol. 2, pp. 71–162. Amsterdam: North Holland.Google Scholar
Ramey, V. A. and Shapiro, M. D. (1998) Costly capital reallocation and the effects of government spending. Carnegie-Rochester Conference Series on Public Policy 48, 145–194.CrossRefGoogle Scholar
Ramey, V. A. and Zubairy, S. (2018) Government spending multipliers in good times and in bad: Evidence from U.S. historical data. Journal of Political Economy 126, 850–901.CrossRefGoogle Scholar
Ravenna, F. and Walsh, C. (2006) Optimal monetary policy with the cost channel. Journal of Monetary Economics 53, 199–216.CrossRefGoogle Scholar
Tillmann, P. (2008) Do interest rates drive inflation dynamics? An analysis of the cost channel of monetary transmission. Journal of Economic Dynamics and Control 32, 2723–2744.CrossRefGoogle Scholar
Supplementary material: PDF

Abo-Zaid supplementary material

Abo-Zaid supplementary material

Download Abo-Zaid supplementary material(PDF)
PDF 1.5 MB