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Spending Reversals and Fiscal Multipliers under an Interest Rate Peg
Author(s) -
LI RONG,
TIAN XIAOHUI
Publication year - 2018
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/jmcb.12488
Subject(s) - economics , government spending , monetary economics , fiscal policy , interest rate , nominal interest rate , monetary policy , real interest rate , shock (circulatory) , fiscal multiplier , multiplier (economics) , inflation (cosmology) , macroeconomics , government (linguistics) , medicine , linguistics , philosophy , physics , theoretical physics , welfare , market economy
This paper examines whether fiscal stimuli are more effective when the monetary policy is less responsive to inflation. First, we provide empirical evidence suggesting that, in the period of U.S. passive monetary policy, a positive government spending shock was followed over time by a spending cut. Second, our theoretical analysis reveals that the pegged nominal interest rate is not a sufficient condition to generate a large fiscal multiplier. An increase in government spending could increase the long‐run real interest rate, if it is associated with a government spending reversal and a less responsive monetary policy. Consequently, the response of private consumption can be negative and the government spending multiplier is not necessarily greater than 1.