Peter McCrory, University of California, Berkeley
ABSTRACT: Local government spending has non-local effects mediated by the trade in intermediate goods; yet, workhorse currency union models ignore this mechanism. To remedy this, I generalize a benchmark currency union model to incorporate trade in intermediate goods between states in the same region. In my framework, there is a local and a spillover (relative) multiplier of government spending. Adding both multipliers together yields the Open Economy Relative Multiplier (OERM), a theoretical object argued in the literature to be an approximate lower bound on the aggregate, closed economy multiplier at the zero lower bound. By implication, the OERM is not equivalent to the local relative multiplier, as is sometimes assumed. Using geographic variation in government spending under the 2009 Recovery Act and import-export linkages between states from the 2007 Commodity Flow Survey, I estimate a local relative multiplier of 1.46 and a spillover relative multiplier of 1.33, implying an OERM of 2.8—approximately doubling previous estimates in the literature.