Menzie and the Multiplier

At Econbrowser: Evolving Views on Fiscal Multipliers

Perhaps the most important insight arising from the debates over fiscal policy during and after the great recession is that the multiplier depends critically on the conduct of monetary policy.

Coenen et al. (2012) show that in DSGEs, the degree of monetary accommodation is critical. When central banks follow a Taylor Rule or inflation forecast based rules, then multipliers are relatively small. However, when monetary policy is accommodative – that is interest rates are kept constant – then the cumulative multiplier is greater.

First, it is interesting that many types of models, including DSGEs, when modified to account for accommodative monetary policy, indicate larger multipliers than found in the previous – pre-liquidity trap – literature.

In comments, 2slugbaits adds:

The key isn't just whether or not the economy is in recession, but the size of the output gap and the response of the central bank. No one doubts that the fiscal multiplier is low if the Fed decides to sterilize any stimulative effect by raising interest rates.

Menzie Chinn in comments:

I define accommodative monetary policy the way most economists do these days: keeping the interest rate constant (or dropping it) as a fiscal impulse is applied, such that the interest rate is less than that implied by a Taylor rule or an inflation forecast based rule (this is the definition in for instance the Coenen et al. paper published in AEJ: Macro cited in the survey.)

Julian Silk in comments:

The whole debate, all of it, is an argument over the assertion that government spending can't be valuable in this sense, so let's get rid of government.