Fiscal shocks and their consequences

This paper investigates the response of hours worked and real wages to fiscal policy shocks in the post-World-War II US. We identify these shocks with exogenous changes in military purchases and argue that they lead to a persistent increase in government purchases and tax rates on capital and labor income, and a persistent rise in aggregate hours worked as well as declines in real wages. The shocks are also associated with short lived rises in aggregate investment and small movements in private consumption. We describe and implement a methodology for assessing whether standard neoclassical models can account for the consequences of a fiscal policy shock. Simple versions of the neoclassical model can account for the qualitative effects of a fiscal shock. Once we allow for habit formation and investment adjustment costs, the model can also account reasonably well for the quantitative effects of a fiscal shock.     

Monetary policy and fiscal limits with no-default

This paper discusses monetary and fiscal policy interactions that stabilize government debt. Two distortions prevail in the model economy: income taxes and liquidity constraints. Possible obstructions to fiscal policy include a ceiling on the equilibrium debt-to-GDP ratio, zero or negative elasticity of tax revenues, and a political intolerance of raising tax rates. At the fiscal limit two mechanisms restore solvency: fiscal inflation, which reduces the real value of nominal debt, and open market operations, which diminish the size of government debt held by the private sector. Three regimes achieve this goal. In all regimes monetary policy is passive. In all regimes a muted tax response to government debt is consistent with equilibrium. The propensity of a fiscal authority to smooth output is found to determine what is an acceptable response (in the form of tax rate changes) to the level of government debt, while monetary policy determines the timing and magnitude of fiscal inflation. Impulse responses show that the inflation and tax hikes needed to offset a permanent shock to transfers are lowest under nominal interest rate pegs. In this regime, most of the reduction in the real value of government debt comes from open market purchases.     

Fiscal multipliers in a structural VEC model with mixed normal errors

This paper estimates the effects of fiscal policy shocks on GDP in the United States with a vector error correction (VEC) model in which shocks are identified by exploiting the non-normal distribution of the model residuals. Unlike previous research, the model used here takes into account cointegation between the variables, and applies a data driven method to identify fiscal policy shocks. The approach also allows statistical testing of previous identification strategies, which may help discriminate between them and hence also explain differences between various fiscal multiplier estimates. Our results show that a deficit financed government spending shock has a weak negative effect on output, whereas a tax increase to finance government spending has a positive impact on GDP.     

Variation in the fiscal multiplier with the method of financing: evidence across industrial countries

Government spending has often varied with the business cycle to stimulate the economy and to revive economic conditions. However, the state of public finances has often necessitated higher borrowing to finance widening fiscal deficits. Indeed, recent austerity packages around the globe have crystalized the importance of fiscal consolidation against the backdrop of rising public debt. To shed light on recent debates regarding fiscal multipliers, the article estimates variation in these multipliers with the method of financing, using annual data for a sample of industrial countries. There is a large variation in the effects of expansionary and contractinary government spending shocks on economic variables within and across countries. The significant effects of negative government spending shocks (fiscal contraction) appear more prevalent than those of expansionary shocks on real output growth, price inflation and nominal wage inflation. Consistent with theory’s predictions, the fiscal multiplier is more likely to be negative when government spending is financed by issuing debt and less likely in the case of monetization. The evidence confirms concerns about the negative effect of higher debt and more expensive financing on private activity, countering the effectiveness of fiscal policy.     

Swedish Postwar Business Cycles: Generated Abroad or at Home?

The relative importance of foreign and domestic shocks for the Swedish postwar business cycle is examined in a neoclassical stochastic growth model of a small open economy. Since recent research has shown that fiscal policy shocks may be important for business cycles, I extend previous work in the literature by allowing for stochastic fiscal policy. It is found that the introduction of fiscal policy improves the empirical fit of the model, although not significantly so when hours worked are detrended with the HP filter. The results suggest that domestic shocks are more important than foreign shocks for output fluctuations. Among the domestic shocks, innovations in fiscal policy seem to have been more important than technology shocks during this period. Foreign shocks are very important for fluctuations in the real exchange rate and the current account.     

The macroeconomic effects of fiscal policy

We investigate the macroeconomic effects of fiscal policy using a Bayesian Structural Vector Autoregression (B-SVAR) approach. We identify fiscal policy shocks via a partial identification scheme, but also: (i) include the feedback from government debt; (ii) look at the impact on the composition of output; (iii) assess the effects on asset markets; (iv) use quarterly data; and (v) analyse empirical evidence from the US, the UK, Germany and Italy. The results show that government spending shocks, in general, have a small effect on Gross Domestic Product (GDP); lead to important ‘crowding-out’ effects; have a varied impact on housing prices and generate a quick fall in stock prices. Government revenue shocks generate a mixed effect on housing prices and a small and positive effect on stock prices. The empirical evidence also suggests that it is important to explicitly consider the government debt dynamics in the model.     

PRODUCTIVE GOVERNMENT EXPENDITURE IN MONETARY BUSINESS CYCLE MODELS

This paper assesses the transmission of fiscal policy shocks in a New Keynesian framework where government expenditures contribute to aggregate production. It is shown that even if the impact of government expenditures on production is small, this assumption helps to reconcile the models' predictions about fiscal policy effects with recent empirical evidence. In particular, it is shown that government expenditures can lead to a rise in private consumption, real wages, and employment if the government share is not too large and public finance does not solely rely on distortionary taxation. When government expenditures are partially financed by public debt, unit labor costs fall in response to a fiscal expansion, such that inflation tends to decline. Households are willing to raise consumption if monetary policy is active, i.e. ensures that the real interest rate rises with inflation. Otherwise, private consumption can also be crowded out, as in the conventional case where government expenditures are not productive.     

Economic policy uncertainty and real output: evidence from the G7 countries

We use economic policy uncertainty index, and impulse response based test to assess the impact of economic policy-related uncertainty on real economic activity. We use monthly data, over the period from 1985:1 to 2015:3, and impulse response functions to investigate how the economies of the G7 countries respond to positive and negative economic policy uncertainty shocks of different magnitudes. We find that economic policy uncertainty is countercyclical, that the effects of uncertainty shocks increase with size and that the responses of real output to positive and negative economic policy uncertainty shocks are country specific. Our research is important for policymaking and in favour of policies that remove economic uncertainty and its negative effects on the economy. We argue that some control over yellow journalism, a transparent tax system and a set of predictable fiscal and monetary policies can minimize the social costs of economic policy uncertainty.     

Fiscal deficits,banking crises and policy reversal in a semi-open economy

We study the effect of domestic policies and external shocks in a semi-open economy characterized by incomplete liberalization of the financial sector. We argue that in such transition economies stabilization programs can have a negative impact on the fiscal imbalances, offsetting to some extent the very achievement of the stabilization program. We develop a simple general equilibrium model which allows propagation of shocks in the presence of government guarantees and imperfect capital mobility. We also empirically test the impact of positive foreign interest shock on the Indian economy using a reduced form VAR approach. The econometric evidence, though broadly consistent with the main predictions of the model, suggests no significant impact of foreign interest rate shock on output and credit. We conclude that incomplete liberalization of the financial sector in transition economies has two effects. It reduces i) exposure to external financial shocks (like the current credit crisis) and ii) ability to deal with real sector shocks (which may arise from global recession in the medium term) due to endogenous policy reversals and presence of government guarantees.     

How does population aging affect the effectiveness of fiscal stimulus over the business cycle?

What is the impact of population aging on the effectiveness of fiscal stimulus over the business cycle? We address this question by estimating state-dependent fiscal multipliers in member countries of the Organisation for Economic Co-operation and Development (OECD). A government spending shock is identified as a forecast error of government spending and its output effect is estimated by using the local projection method. We find that there is no effect of population aging on output effects of fiscal spending shocks in expansionary times, whereas in recessions the output effects of fiscal spending shocks are weakened as population ages. This result points to important policy implications in that population aging would call for a larger fiscal stimulus to support aggregate demand during recession. Thus, this requires a larger fiscal space to allow for a wider swing of the fiscal position without creating concerns for fiscal sustainability.     

Fiscal policy in a small open economy with cross-border labor mobility

The large and stable inflow of workers’ remittances through formal financial channels to developing countries prompted authorities to harness fiscal resources from this flow. This paper develops a macro-dynamic model of a small open economy with cross-border labor mobility emphasizing fiscal policy. The flow of remittances is the result of a household’s optimizing decision to migrate. We examine the macroeconomic responses to fiscal policies. First, we show that an economy with international migration is more resilient to demand shocks resulting from fiscal contraction. Second, the short-run association between remittances and domestic output depends on the sources of the shocks. Third, our results indicate that the equilibrium impact of a tax on remittances can be expansionary and welfare-improving when an economy is initially close to full employment. The presence of utility-enhancing government expenditure and a potential negative externality from over-allocation of labor abroad (over migration) justify the presence of distortionary taxes.     

RE-EXAMINING THE EFFECTIVENESS OF STABILISATION POLICY

This paper develops an alternative international macroeconomic model for evaluating the effectiveness of fiscal and monetary policy in stabilising national income under fixed and floating exchange rates. It encompasses national output and income, saving, investment, money and capital flows and linkages between the exchange rate, price levels and real interest rates consistent with international parity conditions. It demonstrates that the nature of government spending is pivotal to the effectiveness of fiscal policy, revealing that, ceteris paribus , higher public consumption expenditure contracts national income and depreciates the exchange rate, whereas higher productive public investment spending has opposite effects. The framework also shows that the effectiveness of fiscal and monetary policy as macroeconomic policy instruments is not ultimately dependent on the exchange rate regime.     

财政政策与国际收支:从微观作用机制考察

财政政策影响国际收支存在三个微观机制,即产出-吸收效应,储蓄-投资效应以及汇率效应.这本来是一国当局为实现内部均衡实行扩张性财政政策时,对外部均衡产生的一个被动结果.但同时,从政府的角度而言,一旦掌握了其中的作用机制,当局完全可以运用财政政策在调节国际收支平衡中发挥积极作用.     

FISCAL POLICY AND ASSET PRICES

We analyse the impact of fiscal policy on asset prices using a panel vector auto‐regressive (PVAR) approach and quarterly data for ten industrialized countries. We find that positive fiscal shocks lead to a temporary fall in stock prices and a gradual and persistent decrease in housing prices. The empirical findings also point to: (i) a contractionary effect of fiscal policy on output in line with the existence of crowding‐out effects and the deterioration of credit conditions; (ii) a weakening of the effectiveness of fiscal policy in recent times; (iii) a more persistent response of asset prices for countries with a lower degree of openness; (iv) a larger impact of fiscal policy on asset prices for small countries; (v) a close link between the responsiveness of asset prices to fiscal policy and the government’s size; (vi) an increase of the sensitivity of asset prices to fiscal policy shocks following the process of financial deregulation and mortgage liberalization; and (vii) significant fiscal multiplier effects in the context of severe housing busts. Finally, the evidence suggests that changes in equity prices may help governments towards consolidation of public finances.     

The dynamic effects of monetary policy and government spending shocks on unemployment in the peripheral Euro area countries

In this paper we study the response of unemployment to monetary policy and government spending shocks in the peripheral Euro-area countries. By applying the structural near-VAR methodology, we jointly model area-wide and national variables. Our main finding is that fiscal multipliers vary across countries and the results are consistent with the prediction of the standard New Keynesian model only in Italy and Greece. Instead, in Ireland, Portugal and Spain increases in government spending are recessionary. Thus we find that Keynesian results of fiscal policy seem to prevail in high public-debt countries, whereas non-Keynesian outcomes seem to characterize high private-debt countries. As for the monetary policy shock, we find that it plays an important role, jointly with the other area-wide shocks, as a long-term driver of national unemployment.     

To react or not? Technology shocks, fiscal policy and welfare in the EU-3

This paper develops a dynamic stochastic general equilibrium (DSGE) model to examine the quantitative macroeconomic implications of counter-cyclical fiscal policy for France, Germany and the UK. The model incorporates real wage rigidity and consumption habits, as the particular market failures justifying policy intervention. We subject the model to productivity shocks and allow policy instruments to react to the output gap and the debt-to-output ratio. A welfare analysis reveals that the most effective instrument-target combination is to use public consumption to stabilize the output gap. Moreover, welfare gains from counter-cyclical fiscal policy are much stronger in the presence of wage rigidities compared with consumption habits. Finally, since active policy and automatic stabilizers are substitutes, it is possible that relatively undistorted economies may be in need of countercyclical fiscal action due to inadequate automatic stabilizers.     

Commodity prices and fiscal policy in a commodity exporting economy

This paper analyzes the macroeconomic effects of commodity price shocks on a commodity exporting country. In doing so, we use a DSGE model developed to describe the business cycle in Chile, a copper exporting country. We compare the effects of commodity-price shocks under different fiscal rules. The results show that if the fiscal policy is conducted in a way such that the government saves most of the extra revenues from the higher commodity price, then the macroeconomic effects of a commodity price increase of 10% are an expansion of output below 0.2% and a real exchange appreciation of 0.5%. In contrast, when fiscal policy is highly expansive, the same commodity price increase implies an output expansion above 0.5% and a real exchange rate appreciation of 0.8%. With our model, we also analyze the effects of persistent reduction in the commodity price, the relevance of exchange rate flexibility and the role of imperfect credibility of the fiscal rule.     

Foreign Debt,Foreign Direct Investment and Volatility

We investigate how foreign debt and foreign direct investment (FDI) affect the growth and welfare of a stochastically growing small open economy. First, we find that foreign debt influences the growth of domestic wealth by lowering the cost of capital, while FDI affects the country's welfare by providing an additional source of permanent income. Second, a decline in domestic investment may improve domestic welfare as FDI replaces the gap. Even when the welfare deteriorates, its magnitude is mitigated, leaving more room for discretionary fiscal policy. Third, a fiscal policy aimed to stabilize domestic output fluctuations needs to be conducted not to crowd out the welfare benefit of FDI too much. Fourth, an economy with both types of foreign capital experiences wider welfare swings by external volatility shocks than the one with foreign debt alone, while the welfare effects from domestic volatility shocks are mitigated. The welfare effects of fiscal shocks are much smaller with both types of foreign capital. Lastly, the first-best labor income tax covers the government absorption by the labor's share of total output, and the capital income tax covers the rest. Investment is penalized or subsidized depending on the social marginal cost-gain differential.     

Forecasting output gaps in the G-7 countries: the role of correlated innovations and structural breaks

Trend GDP and output gaps play an important role in fiscal and monetary policy formulation, often including the need for forecasts. In this article, we focus on forecasting trend GDP and output gaps with Beveridge-Nelson trend-cycle decompositions trend-cycle decompositions and investigate how these are affected by assumptions concerning correlated innovations and structural breaks. We evaluate expanding window, one-step-ahead forecasts indirectly for the G-7 countries on the basis of real GDP growth rate forecasts. We find that correlated innovations affect real GDP growth rate forecasts positively, while allowing for structural breaks works for some countries but not for all. In the face of uncertainty, the evidence supports that in making forecasts of trends and output gap policy-makers should focus on allowing for the correlation of shocks as an order of priority higher than unknown structural breaks.     

The macroeconomic effects of fiscal policy in Portugal: a Bayesian SVAR analysis

With a new quarterly dataset we estimate a Bayesian Structural Autoregression model and a Fully Simultaneous System approach to analyze the macroeconomic effects of fiscal policy. Results show that positive government spending shocks, in general, have a negative effect on real GDP; lead to “crowding-out” effects of private consumption and investment; have a persistent and positive effect on the price level and a mixed impact on the average financing cost of government debt. Explicitly considering the government debt dynamics in the model is also important. A VAR counter-factual exercise confirms that unexpected positive spending shocks create relevant “crowding-out” effects.