JVM Seminar: Pontus Rendahl (Cambridge)

Apr 04, 2017, 17:00 - 18:30, IHS, Seminar Room 101

Deconstructing the Fiscal Multiplier

Pontus Rendahl (University of Cambridge)

The fiscal multiplier is not a parameter, but the equilibrium outcome of several simultaneously operating mechanisms. In particular, the recent theoretical literature has emphasized the role of expectations as the key channels that determines the efficacy of countercyclical government spending. Using an expectations augmented structural vector autoregression (SVAR), this paper assesses the extent to which expectations of future output and inflation may explain the presence, and size, of a fiscal multiplier. Using several identification procedures and a wide range of decomposition techniques, our results can be summarized as follows: First, a rise in government spending is associated with a persistent rise in both output and expected output, as well as a decline in inflation and expected inflation. Second, the rise in output is largely attributable to the rise in expected output, while the role of expected inflation plays a negligible role. Lastly, using several counterfactual experiments, we find that the rise in expected output is a large causal determinant of the efficacy of fiscal policy, while expected inflation is not. Our results are broadly supportive of the transmission mechanisms identified in the theoretical literature, but emphasizes the role of expected output to a much larger extent than previously acknowledged.

Joint work with Saleem Bahaj