Macroeconomics

Multiplier (economics)

Shock (circulatory)

Fiscal policy

Economics

Market economy

Keynesian economics

Monetary economics

Government spending

Internal medicine

Welfare

Fiscal multiplier

Medicine

The Review of Economic Studies

This article argues that an important, yet overlooked, determinant of the government spending multiplier is the direction of the fiscal intervention. Regardless of whether we identify government spending shocks from (1) a narrative approach or (2) a timing restriction, we find that the contractionary multiplier—the multiplier associated with a negative shock to government spending—is above 1 and largest in times of economic slack. In contrast, the expansionary multiplier—the multiplier associated with a positive shock—is substantially below 1 regardless of the state of the cycle. These results help understand seemingly conflicting results in the literature. A simple theoretical model with incomplete financial markets and downward nominal wage rigidities can rationalize our findings.

Understanding the Size of the Government Spending Multiplier: It’s in the Sign