Trend productivity growth and the government spending multiplier

• We incorporate trend growth into a New-Keynesian model with price and wage rigidity.
• Trend growth introduces a hump-shaped response of output to a government spending shock.
• Output is lower on impact but more persistent in response to higher government spending.
• The impact fiscal multiplier decreases and the cumulative multiplier increases with trend growth.

The paper analyzes the effects of government spending shocks under alternative rates of trend growth in a New-Keynesian model characterized by price and wage rigidity. We show that the presence of trend growth makes the impact on output and consumption of government spending shocks smaller but more persistent with a hump shaped impulse response. Our results imply that the impact government spending multiplier decreases while the cumulative multiplier increases with trend growth.