Fiscal Multipliers: Liquidity Traps and Currency Unions

Emmanuel Farhi, Iván Werning

NBER Working Paper No. 18381
Issued in September 2012
NBER Program(s):Economic Fluctuations and Growth, International Finance and Macroeconomics, Monetary Economics

We provide explicit solutions for government spending multipliers during a liquidity trap and within a fixed exchange regime using standard closed and open-economy models. We confirm the potential for large multipliers during liquidity traps. For a currency union, we show that self-financed multipliers are small, always below unity. However, outside transfers or windfalls can generate larger responses in out- put, whether or not they are spent by the government. Our solutions are relevant for local and national multipliers, providing insight into the economic mechanisms at work as well as the testable implications of these models.

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w18381