Stimulus: Worse Than Imagined

I previously highlighted the paper by Cogan, Cwik, Taylor, and Wieland that outlines the differences in Old Keynesian and New Keynesian multipliers. However, it seems that the differences might be worse than imagined.

Harold Uhlig’s presentation from the Atlanta Fed conference on fiscal policy explains the effects of stimulus when one assumes the presence of distortionary labor taxation. (He also examines the implications if rule-of-thumb consumers and the zero lower bound.) Here is what he finds:

In the context of this model, the impact of a government spending stimulus …

  • … is very sensitive to assumptions about taxes.
  • … on output is rarely larger than the government spending increase
  • … is a comparatively larger output loss later on, due to the increased tax burden.

Furthermore,

  • Consumption declines.
  • Rules-of-thumb agents do not change the results much. Consumption may be feebly positive, the increase in output is somewhat larger.
  • Binding zero lower bound: does not change the results much, if temporary, and is extreme and fragile, if longer.

Similar to the paper by Cogan, et. al, the baseline framework that Uhlig uses is the Smets-Wouters model. I cannot find a copy of the paper online. Nevertheless, the link above is to the presentation from the conference and provides substantial information for understanding the framework and assumptions.

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