Are multipliers larger than we thought?

In the last years, much of the debate on fiscal stimulus vs. austerity was centered on the measurement of government spending multipliers. And to a large extend this was a debate between those how used dynamic stochastic general equilibrium (DSGE) models, finding small multipliers, and those using reduced form models, finding large multipliers. Both strategies have pitfalls, the structural one in that the model may be miss-specified as it is always an abstraction of a complex reality, the reduced-form one because of the Lucas Critique.

Patrick Fève, Julien Matheron and Jean-Guillaume Sahuc make the point that there could be a source of downward bias in the estimation of the elasticity in structural models. It arises from ignoring the endogeneity of government expenses combined with complementarity between public and private consumption. With exogenous expenses, the elasticity is 0.97 for the United States, with endogenous ones, it is 1.31. No small potatoes.