Endogenous Government Spending and Fiscal Stimulus (Incomplete Version)

Government spending multiplier is usually defined as a factor of proportionality that measures how much output changes in response to a change in the exogenous government spending shock. This assumption is inconsistent with the reality that fiscal stimulus are themselves endogenous and state dependent. This paper developed a endogenous regime switching framework in a rational expectation DSGE model to study the counter-cyclical fiscal policy–the unproductive government spending increases only in recession, the regime switch is triggered when certain endogenous variables cross the specified threshold. The model justifies the important role of the counter-cyclical fiscal policy. By comparing the exogenous and endogenous government spending, the model finds out the multiplier effect can be very different in the short and long run. JEL Classification: E62 H30 H50 ∗Department of Economics, Indiana University, 105 Wylie Hall, 100 S. Woodlawn, Bloomington, IN 47405, [email protected]. I am grateful to my advisor, Eric Leeper for inspiring my interest on this topic. I also thank Todd Walker and Bulent Guler for helpful comments and suggestions. In addition, I thank Troy Davig and Huixin Bi for helpful conversation.