Cyclical Fiscal Multipliers: Policy Mix and Financial Friction Puzzle

Cyclical Fiscal Multipliers: Policy Mix and Financial Friction Puzzle
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Volume/Issue: Volume 2025 Issue 108
Publication date: May 2025
ISBN: 9798229011242
$20.00
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Topics covered in this book

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Economics- Macroeconomics , Public Finance , State-dependent multipliers , Business cycle , Policy mix , Business cycles , Fiscal multipliers , Economic recession , Global

Summary

This paper investigates dynamic relationships between U.S. government expenditure multipliers and the economy's cyclical position from 1949 to 2018 using a Time-Varying Parameter Vector Autoregression (TVP-VAR) model. We challenge the existing literature, which predominantly relies on predefined economic regimes and assumes a stable relationship between fiscal multipliers and business cycles. Our findings identify two distinct periods: fiscal multipliers were counter-cyclical from 1949 to the late 1980s, followed by a significant decline in their effectiveness during recessions thereafter. These variations are attributed to the prevailing fiscal-monetary policy mix; with higher fiscal multipliers during earlier recessions resulting from sharp shifts toward a fiscally led policy stance, followed by a decline after the Dot-com recession due to a transition toward a monetary-led policy mix. We find particularly low multipliers during the global financial crisis, which provides new insights into the evolving role of financial frictions in the transmission of fiscal policy.