The Output and Welfare Effects of Government Spending Shocks over the Business Cycle

How does the output response to a change in government spending vary over the business cycle? What are the welfare effects of spending shocks? This paper studies the state-dependence of the output and welfare effects of shocks to government purchases in a DSGE model with real and nominal frictions and a rich fiscal financing structure. Both the output multiplier (the change in output for a one dollar change in government spending) and the welfare multiplier (the consumption equivalent change in welfare for the same change in spending) move significantly across states. The magnitudes of the output and welfare multipliers tend to move opposite from one another across states of the business cycle. In an historical simulation, the output multiplier is countercyclical (correlation with detrended output of -0.4) and strongly negatively correlated with the welfare multiplier (correlation between multipliers of -0.9).