Does the population share of rule-of-thumb consumers matter for the size of the fiscal multiplier?

Why is it interesting?
This comparison evaluates the sensitivity of fiscal policy effects to the parameters governing household consumption choices. It compares the effects of government spending depending on the share of Keynesian-style rule-of-thumb households (w) – those that simply consume all current disposable income. Three cases are considered – share of 0 percent (all consumers are forward-looking and base their decision on expected life-time income), 26.5 percent (estimated value within the model) and 50 percent (an upper limit of estimates found in the literature on the U.S. economy).

What to do on the MMB?
Go to "Menu" > "Edit Rules/Models" and click the plus icon to add two additional models (in this example, US_CCTW100 and US_CCTW100265). Then copy the json and the mod file from US_CCTW10 and paste them in the two new models. Change model names in the json and mod files of the two new models. Set "omega" to 0 and 0.265 in the mod file of US_CCTW100 and US_CCTW100265 respectively. Click "Save" every time a change is made.
  • Models: US_CCTW10, US_CCTW100, US_CCTW100265
  • Policy Rules: Model specific rule
  • Shocks: Fiscal Policy Shock
  • Variables: Inflation, Interest, Output

What is interesting?
The effect on GDP increases with the population share of rule-of-thumb consumers. Yet, the quantitative differences in the GDP impact of the fiscal shock are not very large. The reason is that a crowding-out effect becomes more pronounced with a larger share of rule-of-thumb consumers. In response to higher GDP and higher inflation, the central bank raises the nominal interest rate (real interest rate rises as well, consequently) and by a larger amount for higher values of w. Higher real rates reduce demand for investment purposes and incentivize forward-looking households to postpone consumption. Therefore, the expansion in government spending crowds out private spending on investment and consumption.

Reference: Afanasyeva E., Kuete M., Wieland V. & Yoo J. (2016)
Edited by Milivojevic L.