Fiscal Stimulus and Distortionary Taxation

Abstract

First Draft: January 2, 2010 This Draft: November 13, 2013 We quantify the fiscal multipliers in response to the American Recovery and Reinvestment Act (ARRA) of 2009. We extend the benchmark Smets-Wouters (2007) New Keynesian model, allowing for credit-constrained households, the zero lower bound, government capital, and distortionary taxation. The posterior yields modestly positive short-run multipliers around 0.53 and modestly negative long-run multipliers around -0.36. We explain the central empirical findings with the help of a simple three equation New Keynesian model with sticky wages and credit-constrained households.

Keywords: Fiscal Stimulus, New Keynesian model, liquidity trap, zero lower bound, fiscal multiplier

JEL Classification: E62, E63, E65, H20, H62