A Pitfall with DSGE–Based, Estimated, Government Spending Multipliers

We stress a potential source of bias in the GSM arising from the combination of Edgeworth complementarity between private consumption and government expenditures and countercyclical government expenditures. Due to cross-equation restrictions, omitting the endogenous component of government policy at the estimation stage would lead an econometrician to underestimate the degree of Edgeworth complementarity and, consequently, the long-run GSM. An estimated version of our model with US postwar data shows that this bias matters quantitatively.