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The paper studies the macroeconomic effects of government spending shocks in an economy characterized by positive trend growth. It shows that the lower is the trend growth rate the less inflationary are government spending shocks and vice versa. Moreover, on impact output is higher but exhibits less persistence the lower is trend growth, an effect that also characterizes consumption and the government spending multiplier, given that consumption and labor are somewhat complementary. In response to the recent global recession caused by the financial crisis of 2007, many governments resorted to fiscal policy once monetary policy was constrained by the zero lower bound of the short-term interest rate.
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