Regional Heterogeneity and Aggregate Fiscal Mulitplier

Abstract

I examine the role of household heterogeneity in the transmission of government expenditure. Exploiting regional variation in military procurement spending in the US, I find that the local multipliers of government spending are negatively correlated with the share of hand-to-mouth in the region. Econometrically, heterogeneous effects across regions introduce a bias to previous estimates of the average local multiplier. Correcting the bias reduces the average local multiplier to below 1 and brings back the absent inflationary responses. A monetary union TANK model can reproduce the average local multiplier, but not the negative relationship between the local multipliers and the share of hand-to-mouth. Using contract-level data, I present evidence on the transmission mechanisms of military spending and argue that the puzzling negative relationship is driven by the special composition of military spending.