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Should we use linearized models to calculate fiscal multipliers?
Author(s) -
Lindé Jesper,
Trabandt Mathias
Publication year - 2018
Publication title -
journal of applied econometrics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.878
H-Index - 99
eISSN - 1099-1255
pISSN - 0883-7252
DOI - 10.1002/jae.2641
Subject(s) - zero lower bound , multiplier (economics) , economics , liquidity trap , new keynesian economics , nonlinear system , fiscal multiplier , market liquidity , phillips curve , econometrics , fiscal policy , keynesian economics , macroeconomics , physics , government spending , liquidity risk , monetary policy , market economy , quantum mechanics , welfare
Summary We calculate the magnitude of the government consumption multiplier in linearized and nonlinear solutions of a New Keynesian model at the zero lower bound. Importantly, the model is amended with real rigidities to simultaneously account for the macroeconomic evidence of a low Phillips curve slope and the microeconomic evidence of frequent price changes. We show that the nonlinear solution is associated with a much smaller multiplier than the linearized solution in long‐lived liquidity traps, and pin down the key features in the model which account for the difference. Our results caution against the common practice of using linearized models to calculate fiscal multipliers in long‐lived liquidity traps.