Understanding the size of the government spending multiplier: It's in the sign

Abstract

Despite intense scrutiny, estimates of the government spending multiplier remain highly uncertain, with values ranging from 0.5 to 2. While an increase in government spending is generally assumed to have the same (mirror-image) effect as a decrease in government spending, we show that relaxing this assumption is important to understand the effects of fiscal policy. 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, while the expansionary multiplier -the multiplier associated with a positive shock- is substantially below 1. The multiplier is largest in recessions, as found in previous studies, but only because the contractionary multiplier is largest in recessions. The expansionary multiplier is always below 1 and not larger in recessions. We argue that our results help understand the wide range of multiplier estimates found in the literature.