The paper “Fiscal Multipliers in the 21st Century”, joint with Hans Holter, Per Krusell and Laurence Malafry, was accepted for publication in the Journal of Monetary Economics (forthcoming in January 2016) and can be accessed here.
In the paper we document a positive association between wealth inequality within a country and the effectiveness of fiscal policy. More precisely, the expansionary effect of an increase in government expenditures is higher in countries with higher wealth inequality. We build a benchmark model calibrated to the U.S. economy in order to better understand the mechanisms connecting wealth inequality and fiscal multipliers.
We identify two main channels through which we explain the positive association between wealth inequality and fiscal multipliers. Credit constraints make labor supply of the poorest agents much more responsive to negative shocks to income (as the ones used to finance the increase in government expenditures) and thus increase the magnitude of the fiscal response. A higher capital-output ratio leads to a smaller equilibrium interest rate and consequently a higher net present value of lifetime income, which makes the same government consumption shock smaller in relative size and consequently to a smaller response of output.
Once identified these mechanisms, we extend the analysis to 15 OECD countries, matching wealth distributions, consumption taxes, capital taxes, social security systems, wage dispersion and a number of other features of each economy and are not only able to replicate the same positive and significant relationship between wealth inequality and the size of the multiplier, but also to confirm the relevance of the mechanisms described above.