The Government Spending Multiplier, Fiscal Stress and the Zero Lower Bound

The sovereign debt crisis in the euro area was characterized by a monetary policy, which has been constrained by the zero lower bound (ZLB) on nominal interest rates, and several countries, which faced high risk spreads on their sovereign bonds. The author develops a DSGE model that captures the ZLB and fiscal stress and analyzes the effects of government spending shocks. He finds that not only are multipliers large at the ZLB, the presence of fiscal stress can even increase their size.