The Nonlinear Effects of Fiscal Policy

65 Pages Posted: 14 May 2021

See all articles by Pedro Brinca

Pedro Brinca

Nova School of Business and Economics; CEF.UP

Miguel Faria-e-Castro

Federal Reserve Bank of St. Louis

Miguel H. Ferreira

Independent

Hans Holter

University of Oslo

Multiple version iconThere are 3 versions of this paper

Date Written: May 1, 2019

Abstract

We argue that the fiscal multiplier of government purchases is nonlinear in the spending shock, in contrast to what is assumed in most of the literature. In particular, the multiplier of a fiscal consolidation is decreasing in the size of the consolidation. We empirically document this fact using aggregate fiscal consolidation data across 15 OECD countries. We show that a neoclassical life-cycle, incomplete markets model calibrated to match key features of the U.S. economy can explain this empirical finding. The mechanism hinges on the relationship between fiscal shocks, their form of financing, and the response of labor supply across the wealth distribution. The model predicts that the aggregate labor supply elasticity is increasing in the fiscal shock, and this holds regardless of whether shocks are deficit- or balanced-budget financed. We find evidence of our mechanism in microdata for the US.

JEL Classification: E21, E62

Suggested Citation

Brinca, Pedro and Faria-e-Castro, Miguel and Ferreira, Miguel H. and Holter, Hans, The Nonlinear Effects of Fiscal Policy (May 1, 2019). FRB St. Louis Working Paper No. 2019-015, Available at SSRN: https://ssrn.com/abstract=3843860 or http://dx.doi.org/10.20955/wp.2019.015

Pedro Brinca (Contact Author)

Nova School of Business and Economics ( email )

Campus de Campolide
Lisbon, 1099-032
Portugal

HOME PAGE: http://htttp://www.pedrobrinca.pt

CEF.UP ( email )

Rua Dr. Roberto Frias
Porto, 4200-464
Portugal

Miguel Faria-e-Castro

Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

Miguel H. Ferreira

Independent

Hans Holter

University of Oslo ( email )

PO Box 6706 St Olavs plass
Oslo, N-0317
Norway

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