Research / BFI Working PaperMay 12, 2022

Fiscal Policy in a Networked Economy

Joel P. Flynn, Christina Patterson, John Sturm

Advanced economies feature complicated networks that connect households, firms, and regions. How do these structures affect the impact of fiscal policy and its optimal targeting? We study these questions in a model with input-output linkages, regional structure, and household heterogeneity in MPCs, consumption baskets, and shock exposures. Theoretically, we derive estimable formulae for the effects of fiscal policies on aggregate GDP, or fiscal multipliers, and show how network structures determine their size. Empirically, we find that multipliers vary substantially across policies, so targeting is important. Beneath these aggregate effects are large spatial and sectoral spillovers from policies directed to any one firm or household. However, virtually all variation in multipliers stems from differences in policies’ direct incidence onto households’ MPCs. Thus, while the distributional effects of fiscal policy depend on the detailed structure of the economy, maximally expansionary fiscal policy simply targets households’ MPCs.

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