Desperate times call for desperate measures: government spending multipliers in hard times

TL;DR

This paper analyzes how fiscal multipliers in the US vary depending on economic slackness, finding larger effects during high unemployment periods, which has implications for fiscal policy during economic crises like COVID-19.

Contribution

It introduces an endogenous method to identify slack periods and demonstrates that fiscal multipliers are significantly larger during these times, with results robust to regime changes.

Findings

Multipliers exceed unity during slack periods.

Estimated multipliers are significantly larger in high unemployment states.

Results are robust under flexible regime frameworks.

Abstract

We investigate state-dependent effects of fiscal multipliers and allow for endogenous sample splitting to determine whether the US economy is in a slack state. When the endogenized slack state is estimated as the period of the unemployment rate higher than about 12 percent, the estimated cumulative multipliers are significantly larger during slack periods than non-slack periods and are above unity. We also examine the possibility of time-varying regimes of slackness and find that our empirical results are robust under a more flexible framework. Our estimation results point out the importance of the heterogenous effects of fiscal policy and shed light on the prospect of fiscal policy in response to economic shocks from the current COVID-19 pandemic.