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The Size of the Multiplier: Comparing Alternate Views After the Great Recession

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The Size of the Multiplier: Comparing Alternate Views After the Great Recession University of Denver Digital Commons @ DU Electronic Theses and Dissertations Graduate Studies 1-1-2019 The Size of the Multiplier: Comparing Alternate Views After the Great Recession Daniel Focht University of Denver Follow this and additional works at: https://digitalcommons.du.edu/etd Part of the Economic History Commons, and the Economic Theory Commons Recommended Citation Focht, Daniel, "The Size of the Multiplier: Comparing Alternate Views After the Great Recession" (2019). Electronic Theses and Dissertations. 1658. https://digitalcommons.du.edu/etd/1658 This Thesis is brought to you for free and open access by the Graduate Studies at Digital Commons @ DU. It has been accepted for inclusion in Electronic Theses and Dissertations by an authorized administrator of Digital Commons @ DU. For more information, please contact [email protected],[email protected]. The Size of the Multiplier: Comparing Alternate Views after the Great Recession __________ A Thesis Presented to the Faculty of Social Sciences University of Denver __________ In Partial Fulfillment of the Requirements for the Degree Master of Arts __________ by Daniel Focht August 2019 Advisor: Dr. Yavuz Yasar Author: Daniel Focht Title: The Size of the Multiplier: Comparing Alternate Views after the Great Recession Advisor: Dr. Yavuz Yasar Degree Date: August 2019 Abstract This thesis reviews the major theoretical frameworks and their outlook on the government spending, its effectiveness, the implied size of the multiplier and how they differed in empirical studies. This is followed by an estimation of the government multiplier for the major U.S. fiscal policy, namely the American Recovery and Reinvestment Act (ARRA), after the Great Recession of 2007-2009. Own estimation of the size of the multiplier is presented using a standard SVAR model based on New Keynesian approach for time period between 2009 and 2018. In addition, following the classical economic theory, the multiplier is recalculated in the absence of Finance, Insurance, and Real Estate (FIRE) sector which is considered to be unproductive sector since it does not add value according to the classical theory. I find the multiplier to be below unity during this period with the exception when the FIRE industries are excluded. Key Words: government spending multiplier, fiscal policy, monetary policy, history of economic thought, econometrics. JEL Classification: E62, E61, E43, H5, B22, B23 ii Table of Contents Chapter 1: Introduction ............................................................................................... 1 Chapter 2: Theoretical Frameworks ........................................................................... 6 2.1 John Maynard Keynes........................................................................................... 6 2.2 Opposition to Keynes ............................................................................................ 9 2.3 New Keynesian Economics ................................................................................ 13 Chapter 3: Literature Review .................................................................................... 21 3.1 State-independent Multipliers ............................................................................. 22 3.2 Cyclical Multipliers ............................................................................................ 24 3.3 Zero Lower Bound Multipliers ........................................................................... 26 3.4 Multiplier after the American Recovery and Reinvestment Act (ARRA) .......... 27 Chapter 4: Impact of Methodology and Theoretical Assumptions ........................ 35 4.1 Choice of Methodology ...................................................................................... 35 4.2 Choice of Theoretical Assumptions .................................................................... 39 Chapter 5: Methodology............................................................................................. 47 5.1 SVAR .................................................................................................................. 47 5.2 Data Description ................................................................................................. 51 5.3 Data Analysis and Context.................................................................................. 52 Chapter 6: Results....................................................................................................... 56 Conclusion ................................................................................................................... 59 Bibliography ................................................................................................................ 62 Appendix ...................................................................................................................... 69 iii List of Figures Figure 1 Real GDP per Capita ...........................................................................................69 Figure 2 Real GDP per Capita Growth ..............................................................................70 Figure 3 Real Government Spending per Capita ...............................................................71 Figure 4 Civilian Unemployment Rate ..............................................................................72 Figure 5 3-Month Treasury Bill: Secondary Market Rate .................................................73 Figure 6 Impulse Response, Estimation 1..........................................................................74 Figure 7 Impulse Response, Estimation 2..........................................................................75 Figure 8 Impulse Response, Estimation 3..........................................................................76 Figure 9 Cumulative Multiplier, Specification 1 ...............................................................77 Figure 10 Cumulative Multiplier, Specification 2 .............................................................78 Figure 11 Cumulative Multiplier, Specification 3 .............................................................79 iv List of Tables Table 1 Aggregate Multipliers by Models and Linearity...................................................80 Table 2 ARRA Multipliers by Cross-state Dependency ....................................................83 Table 3 Cumulative Multiplier, Own Results ....................................................................85 Table 4 VAR Specification 1 .............................................................................................86 Table 5 Granger Causality Wald Test Specification 1.......................................................87 Table 6 VAR Specification 2 .............................................................................................88 Table 7 Granger Causality Wald Test Specification 2.......................................................89 Table 8 VAR Specification 3 .............................................................................................90 Table 9 Granger Causality Wald Test Specification 3.......................................................91 Table 10 ARRA expenditures, initial estimates .................................................................92 Table 11 Output Gap ..........................................................................................................93 Table 12 Full Estimates for Elasticities and Multipliers, Specification 1..........................95 Table 13 Full Estimates for Elasticities and Multipliers, Specification 2..........................97 Table 14 Full Estimates for Elasticities and Multipliers, Specification 3..........................99 v Chapter 1: Introduction In recent days, the government spending multiplier got into the spotlight of the economists and the general public. The Great Recession in the late 2000s proved to be the accelerator for research and interest in this topic as with monetary policy being constrained by zero interest rates, policymakers decided to turn to the fiscal policy to fine-tune the economy. This action, however, was not without its controversy as a share of the politicians, economists and the general public found an expansive fiscal policy to be adverse to the economy. The main disagreement was about whether the government spending multiplier is higher than unity or not. To resolve this issue, many economists decided to estimate the size of the multiplier; however, their efforts never really helped to settle this problem. The results showed a wide range of estimates that would vary from high multipliers, larger than 2, to multipliers close to zero. This heterogeneity is the result of the complexity of the multiplier as there are many variables that affect it such as the state of the economy, the type of the spending shock or the methodology and assumptions that were used. A better understanding of this topic and a general agreement on how fiscal policy should be enacted would help with a more efficient and effective government spending that would not only save taxpayers' money but would also have the ability to support the economy, reduce the harm of downturns and keep the economy longer on track of expansion. 1 The idea of the government spending multiplier started back in the 19th century; however, the generally accepted originator of this concept was John Maynard Keynes. Keynes, through his general framework, claimed that government spending is beneficial as people behave and
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