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Budget-constrained expenditure multipliers
Applied Economics Letters (2011)
  • Ana-Isabel Guerra, Universidad Pablo de olavide
  • Ferran Sancho, Universitat Autonoma de Barcelona
Standard expenditure multipliers capture economy-wide effects of new government projects only when financing constraints are not binding. In actual policy making, however, new projects usually need financing. We show that under liquidity constraints, new projects are subject to two opposite effects: an income effect and a set of spending substitution effects. The former is the traditional, unrestricted, multiplier effect; the latter is the result of expenditure reallocation to upheld effective financing constraints. Unrestricted multipliers will therefore be, as a general rule, upward biased and policy designs based upon them should be reassessed in the light of the countervailing substitution effects. We also propose a novel decomposition of multiplier effects based on internal and external dependencies.
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Ana-Isabel Guerra and Ferran Sancho. "Budget-constrained expenditure multipliers" Applied Economics Letters Vol. forthcoming (2011)
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