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Yes, the Multiplier Is Likely to Be Very Small Away from the Zero Nominal Lower Bound on Interest Rates. Why Do You Ask?

Menzie Chinn Reads the IMF on How the Multiplier Is Bigger in a Depressed Economy

Econbrowser State Dependence and Fiscal Multipliers

Menzie Chinn:

Econbrowser: State Dependence and Fiscal Multipliers: I found this graph from the April IMF Fiscal Monitor of interest…. The authors describe the results underpinning this graph thus:

The model finds significant evidence that the impact of fiscal policy on economic activity varies with the business cycle and that the effect of fiscal policy on output is nonlinear. Average fiscal multipliers in G-7 countries are significantly larger in times of negative output gaps than when the output gap is positive…. Assuming… that two-thirds of the adjustment comes from spending measures, a weighted average of spending and revenue multipliers in downturns yields an overall fiscal multiplier of about 1.0. In line with the bulk of the previous literature (including the survey by Spilimbergo, Symansky, and Schindler, 2009), short-term spending multipliers are found to be significantly higher than revenue multipliers….

Econbrowser State Dependence and Fiscal Multipliers 1

What I find of interest are the US results…. [G]overnment spending has large output effects, particularly in the presence of a negative output gap, once nonlinearities are allowed. Tax revenue changes have much smaller impacts (which are nonsignificant statistically in the linear specification). Similar results are obtained by Auerbach and Gorodnichenko (AEJ:EP, 2012) (ungated version), who use a similar methodology:

Our findings suggest that all of the extensions we developed in this paper—controlling for expectations, allowing responses to vary in recession and expansion, and allowing for different multipliers for different components of government purchases— all have important effects on the resulting estimates. In particular, policies that increase government purchases have a much larger impact in recession than is implied by the standard linear model, even more so when one controls for expectations, which is clearly called for given the extent to which independent forecasts help predict VAR policy “shocks.” Given the historical experience of the US economy, our preferred estimates of the government spending multiplier are between 0 and 0.5 in expansions, and between 1 and 1.5 in recessions.

One interesting implication of these results, beyond the fact that further spending cuts now would be disastrous, is that the hundreds of billions of stimulus during the 2004-08 period –- during which the output gap was slightly positive -- could have been better spent now. (After all, publicly held Federal debt increased by $3.4 trillion going from 2001Q1 to 2009Q1.) Or, as I wrote nearly six years ago:

What we can be certain of is that the choices made by policy makers in the past five years have circumscribed our ability to manage a downturn.