Dissertation Defense: Pedro Juarros
Candidate Name: Pedro Juarros
Major: Economics
Advisor: Mark Huggett, Ph.D.
Title: Essays on Fiscal Policy
The central question when evaluating the effects of government spending on GDP, is
whether the fiscal multiplier is greater or lower than 1, or equivalently, the direction and strength of fiscal spillovers. The empirical evidence reports a wide range of spillovers. This implies that there is no such a thing as a unique fiscal multiplier. The multiplier depends on the characteristics of the economy. I study the role of firm size heterogeneity and credit market imperfections for firms’ financing decisions on the size of the fiscal multiplier. Recent empirical evidence on firm dynamics document that small firms are different from large firms: (i) conditional on surviving, small and young firms grow faster than large and more mature firms, contributing disproportionately to output growth; (ii) small firms are cyclically more sensitive than large firms; and (iii) small firms exhibit different investment, revenues and financing dynamics along the business cycle, and (iv) and are typically more bank dependent and credit constrained. Given this rich heterogeneity across firms: How does firm size heterogeneity affect the fiscal multiplier? Are fiscal spillover heterogeneous by firm size?
I document that the local fiscal multiplier increases with the share of small firms using
cross sectional and time variation in national military procurement and the firm size distribution across metropolitan areas (MSAs) in the US. I show that the median local fiscal multiplier is 1.50 and increases with the employment share of small firms, implying multipliers of 0.95-2.15 in the interquantile range. To explain this fact, I combine local fiscal stimulus with firm level balance sheet information and identifying government contractors, I document positive fiscal spillovers for small firms and neutral for large firms. The results evidence that within firms that did not receive a government contract, small firms increase operating revenues by 11 percentage points (p.p), investment by 5 p.p and their financing by 7.5 p.p relative to large firms in response to an local fiscal stimulus. This implies that small firms are more responsive to local fiscal stimulus than large firms.
To interpret this evidence I propose a heterogeneous firm credit channel of fiscal stimulus. I embed the “financial accelerator” mechanism in a New Keynesian open economy model with two types of firms that have different access to credit markets. Small firms face a higher credit spread in equilibrium that is more sensitive to changes in firms’ balance sheets. The fiscal stimulus improves firms’ net worth, which reduces credit spreads of small firms, and relaxing borrowing constraints. This boosts borrowing, investment and production; and amplifies endogenously the local fiscal multiplier. Calibrated to match cross-sectional and firm level US data, the model can account for 2/3 of the heterogeneous response in firms’ investment. Moreover, the model explains 10-20% of the sensitivity of the local fiscal multiplier to the share of small firms. The model implies that a higher share of small firms also increases the national fiscal multiplier if monetary policy does not respond aggressively to fiscal shocks.
My main contribution is to show that the composition of firms where the fiscal stimulus
takes place is key to the design of fiscal packages aiming to stabilize the economy. I show that the heterogeneous behavior of small and large firms affects the size of the fiscal multiplier