Understanding the Size of the Government Spending Multiplier: It’s in the Sign

Authors: Régis Barnichon, Davide Debortoli and Christian Matthes

Review of Economic Studies, Vol. 89, No 1, 87-117, January, 2022

This paper argues that an important, yet overlooked, determinant of the government spending multiplier is the direction of the fiscal intervention. Regardless of whether we identify government spending shocks from (i) a narrative approach, or (ii) a timing restriction, we find that the contractionary multiplier – the multiplier associated with a negative shock to government spending – is above 1 and largest in times of economic slack. In contrast, the expansionary multiplier – the multiplier associated with a positive shock – is substantially below 1 regardless of the state of the cycle. These results help understand seemingly conflicting results in the literature. A simple theoretical model with incomplete financial markets and downward nominal wage rigidities can rationalize our findings.

This paper originally appeared as Barcelona School of Economics Working Paper 1145