Debt-dependent effects of fiscal expansions

Economists often postulate that fiscal expansions are less stimulative when government debt is high than when it is low. Empirical evidence, however, is ambiguous. Using a nonlinear neoclassical growth model, we show that the difference in government spending effects between high- and low-debt envir...

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Bibliographic Details
Published in:European economic review 2016-09, Vol.88, p.142-157
Main Authors: Bi, Huixin, Shen, Wenyi, Yang, Shu-Chun S.
Format: Article
Language:English
Subjects:
Debt-dependent government spending effect
Deficit financing
Estimating techniques
Fiscal multipliers
Fiscal policy
Fiscal uncertainty
Government spending
Growth models
Labor supply
State-dependent fiscal policy effects
Studies
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Summary:Economists often postulate that fiscal expansions are less stimulative when government debt is high than when it is low. Empirical evidence, however, is ambiguous. Using a nonlinear neoclassical growth model, we show that the difference in government spending effects between high- and low-debt environments depends on the wealth effect on labor supply and on whether the government uses taxes or spending to retire debt. Because of interrelated state variables, structural VAR estimations conditioning on debt alone can fail to isolate debt-dependent effects. Also, uncertainty on when the government will conduct fiscal consolidations generates wide confidence bands for spending multipliers, further complicating efforts to estimate debt-dependent government spending effects.
ISSN:0014-2921
1873-572X
DOI:10.1016/j.euroecorev.2016.04.001