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  5. State Dependent Government Spending Multipliers: Downward Nominal Wage Rigidity and Sources of Business Cycle Fluctuations

American Economic Journal:
Macroeconomics

ISSN 1945-7707 (Print) | ISSN 1945-7715 (Online)

State Dependent Government Spending Multipliers: Downward Nominal Wage Rigidity and Sources of Business Cycle Fluctuations

  • Yoon Joo Jo
  • Sarah Zubairy
American Economic Journal: Macroeconomics (Forthcoming)

Abstract

In a New Keynesian model with downward nominal wage rigidity (DNWR), we show that government spending is more effective in stimulating output in a low-inflation recession relative to a high-inflation recession. The government spending multiplier is large when DNWR binds, but the nature of recession matters due to the opposing response of inflation, and consequently for real wages. Using U.S. historical time series data, we provide evidence of larger spending multipliers in low inflation recessions and the importance of the depth of recessions. We also employ cross-sectional data from U.S. states to document supporting evidence on multipliers and our proposed mechanism.

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