On the Magnitude of the Expenditure Multiplier

We investigate the causes underlying the decline in the government expenditure multiplier after the Korean War. While this phenomenon has been documented before, we look at the decrease in relative multiplier values through the lens of a structural DSGE model, which we estimate using Bayesian methods and annual-frequency data from 1939 to 2017. The model replicates the observed fall in the expenditure multiplier; moreover, using a counterfactual exercise we show that the decline is accounted, for the most part, by changes in two of the model’s structural parameters, namely, a decline in consumption habit persistence and a higher autocorrelation of the public expenditure processes. Taken together, these changes imply a stronger negative wealth effect (over consumption), a lower discretion of U.S. fiscal policy and, consequently, a multiplier of smaller magnitude.