Working Paper Series no. 379: A Pitfall with DSGE-Based, Estimated, Government Spending Multipliers

Abstract

This paper examines issues related to the estimation of the government spending multiplier (GSM) in a Dynamic Stochastic General Equilibrium context. We stress a potential source of bias in the GSM arising from the combination of Edgeworth complementarity/substitutability between private consumption and government expenditures and endogenous government expenditures. Due to cross-equation restrictions, omitting the endogenous component of government policy at the estimation stage would lead an econometrician to underestimate the degree of Edgeworth complementarity and, consequently, the long-run GSM. An estimated version of our model with US postwar data shows that this bias matters quantitatively. The results prove to be robust to a number of perturbations.

Patrick Fève, Julien Matheron et Jean-Guillaume Sahuc
April 2012

Classification JEL : C32, E32, E62

Keywords : : DSGE models, Edgeworth complementarity/substitutability, Government spending rules, Multiplier.