Fiscal Stimulus and Distortionary Taxation

Thorsten Drautzburg and Harald Uhlig
CQER Working Paper 11-01
July 2011

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We quantify the fiscal multipliers in response to the American Recovery and Reinvestment Act of 2009. We extend the benchmark Smets-Wouters New Keynesian model (Smets and Wouters, 2007), allowing for credit-constrained households, the zero lower bound, government capital, and distortionary taxation. The posterior yields modestly positive short-run multipliers around 0.52 and modestly negative long-run multipliers around -0.42. The multiplier is sensitive to the fraction of transfers given to credit-constrained households, the duration of the zero lower bound, and the capital. The stimulus results in negative welfare effects for unconstrained agents. The constrained agents gain if they discount the future substantially.

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

Key words: fiscal stimulus, New Keynesian model, liquidity trap, zero lower bound, fiscal multiplier

This research has been supported by National Science Foundation grant SES-0922550. The authors are grateful to the useful feedback from a number of seminar and conference audiences. The views expressed herein are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to Thorsten Drautzburg, University of Chicago, Department of Economics, 1126 East 59th Street, Chicago, IL 60637,, or Harald Uhlig, University of Chicago, CentER, NBER and CEPR, Department of Economics, 1126 East 59th Street, Chicago, IL 60637,

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