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The 2009 Recovery Act and the Expected Inflation Channel of Government Spending

There exist sticky price models in which the output response to a government spending change can be large if the central bank is nonresponsive to inflation. According to this “expected inflation channel," government spending drives up expected inflation, which in turn, reduces the real interest rate and leads to an increase in private consumption. This paper examines whether the channel was important during the 2009 Recovery Act period. Examining U.S. expected inflation measures based on professional surveys and a cross-country comparison of bond yields, we conclude that the Recovery Act had a much smaller expected inflation effect than suggested by an appropriately calibrated large output multiplier" sticky price model. Moreover, we show that the channel is inconsistent quantitatively with vector autoregression evidence from the Federal Reserve's passive policy period. Taking the evidence as a whole, we conclude that if the Act had exhibited a large output multiplier, it was not likely due to the expected inflation channel as formulated in existing research.

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