Labor Market Dynamics and the Business Cycle: Structural Evidence for the United States*

We use a 12‐dimensional VAR to examine the aggregate effects of two structural technology shocks and two policy shocks. For each shock, we examine the dynamic effects on the labor market, the importance of the shock for labor market volatility, and the comovement between labor market variables and other key aggregate variables in response to the shock. We document that labor market indicators display “hump‐shaped” responses to the identified shocks. Technology shocks and monetary policy shocks are important for labor market volatility but the ranking of their importance is sensitive to the VAR specification. The conditional correlations at business cycle frequencies are similar in response to the four shocks, apart from the correlations between hours worked, labor productivity and real wages. To account for the unconditional correlations between these variables, a mixture of shocks is required.     

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.     

Wage Rigidity, Monetary Integration and Fiscal Stabilization in Europe

Flexibility in fiscal policy is a necessary ingredient in a policy package for EMU. Even with strong endogenous shock absorbers, such as real wage flexibility, fiscal policy can speed up the stabilization process in response to demand shocks. If real wages are rigid, as they typically are in Europe, fiscal policy cannot remove the adverse effects of asymmetric supply shocks, but it can successfully limit the divergence between member states. Monetary flexibility, a possible option in the run-up to EMU, cannot completely make up for the stabilization function of fiscal policy.     

Understanding the Effects of a Shock to Government Purchases

This paper investigates the consequences of an exogenous increase in U.S. government purchases. We find that in response to such a shock, employment, output, and nonresidential investment rise, while real wages, residential investment, and consumption expenditures fall. The paper argues that a simple variant of the neoclassical growth model which distinguishes between nonresidential and residential investment is consistent with this evidence.Journal of Economic LiteratureClassification Numbers: E1, E6.     

The Role of Real Wages,Productivity, and Fiscal Policy in Germany's Great Depression 1928–1937

We study the behavior of output, employment, consumption, and investment in Germany during the Great Depression of 1928–1937. In this time period, real wages were countercyclical, and productivity and fiscal policy were procyclical. We use the neoclassical growth model to investigate how much these factors contribute to the depression. We find that real wages, which were significantly above their market clearing levels, were the most important factor for the economic decline in the depression. Changes in productivity and fiscal policy were also important for the decline and recovery. Even though our analysis is limited to a small number of factors, the model accounts surprisingly well for the depression in Germany. Journal of Economic Literature Classification Numbers: E13, E32, E62, N14, O47.     

Fiscal policy and national saving

This paper uses structural vector autoregressions along with structural measures of fiscal policy to measure the dynamic impact of fiscal policy shocks on the output gap and national saving. Positive shocks to government purchases and negative shocks to real net taxes are found to increase the output gap. Positive shocks to the government's structural surplus increases national saving although the effects are small. Positive shocks to government purchases are found to substantially reduce national saving. Negative shocks to real net tax revenues as a share of potential GDP have a small negative impact on national saving.     

Consumption multipliers of different types of public spending: a structural vector error correction analysis for the UK

The aim of this paper is to investigate the relationship between government spending and private consumption in the UK, for which there is scarce previous empirical evidence. We disaggregate public expenditure into three categories and search for the corresponding private consumption multipliers. Our analysis is based on the estimation of a structural vector error correction model with quarterly non-interpolated data for the period 1981:1–2007:4. Initially, we estimate negative but barely significant effects on consumption of shocks to total public spending. Then, using the public spending breaking down, we find that while shocks to public wages crowd-out private consumption as predicted by neoclassical models, shocks to the non-systematic component of social spending and government purchases of goods and services generate a positive reaction, so to crowd-in private consumption. Thus, the qualitative and quantitative dimensions of fiscal multipliers on private consumption change across different public spending categories. Our findings suggest that any empirical support of competing theoretical models on the issue would benefit from a disaggregation of government expenditure, rather than focusing on the aggregate measure.     

THE EFFECTS OF FISCAL SHOCKS ON EMPLOYMENT AND THE REAL WAGE*

We study the transmission of fiscal shocks in the labor market. We employ a structural VAR and base identification on the restrictions that shocks to government consumption, investment, and employment must raise output and deficits. These restrictions hold in both prototype Real Business Cycle (RBC) and New Keynesian models. Shocks to government consumption and investment increase real wages and employment contemporaneously, both at state level and in the aggregate. The dynamics in response to employment shocks are mixed: Increases in government employment raise the real wage and total employment in the aggregate. However, in one third of the states they reduce total employment.     

The general equilibrium effects of fiscal policy: Estimates for the Euro area

This paper describes a dynamic stochastic general equilibrium model featuring a fraction of non-Ricardian agents in order to estimate the effects of fiscal policy in the Euro area. The model takes into account distortionary taxation on labor and capital income and on consumption, while expenditures are broken down into purchases of goods and services, compensation of public employees and transfers to households. A newly computed quarterly data set of fiscal variables is used. Our results point to the prevalence of mild Keynesian effects of public expenditures. In particular, although innovations in fiscal policy variables tend to be rather persistent, government purchases of goods and services and compensations for public employees have small and short-lived expansionary effects on private consumption, while innovations in transfers to households show a slightly more sizeable and lasting effect. The effects are more significant on the revenue side: decreases in labor income and consumption tax rates have sizeable effects on consumption and output, while a reduction in capital income tax favors investment and output in the medium run. Finally our estimates suggest that fiscal policy variables contribute little to the cyclical variability of the main macro variables.     

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.     

DOES NEOCLASSICAL THEORY ACCOUNT FOR THE EFFECTS OF BIG FISCAL SHOCKS? EVIDENCE FROM WORLD WAR II*

Much debate surrounds the usefulness of the neoclassical growth model for assessing the macroeconomic impact of fiscal shocks. We test the theory using data from World War II, which is by far the largest fiscal shock in the history of the United States. We take observed changes in fiscal policy during the war as inputs into a parameterized, dynamic general equilibrium model and compare the values of all variables in the model to the actual values of these variables in the data. Our main finding is that the theory quantitatively accounts for macroeconomic activity during this big fiscal shock.     

Markups and fiscal transmission in a panel of OECD countries

This paper studies the role of the markup of price over marginal cost for the transmission of fiscal policy shocks. We construct time series of markups allowing for fluctuations in capacity utilization and total factor productivity and use an aggregate production function that is more general than Cobb–Douglas. Including the constructed markup series in a bias-corrected panel vector autoregression with annual OECD data, we find that a positive shock to government spending tends to lower markups while raising output. The positive output response appears to result less from increases in hours worked than from the positive reaction of capital utilization.     

Sraffa in historiographical perspective: a provisional statement

The paper explores the theory of the aggregate price, profit, and business fluctuations in Keyne's Treatise for its implications for modern macro-economic analysis. As in the Treatise, profits are first defined within a theory of the agregate price level, as aggregate investment minus saving. Deriving aggregate total revenue and aggregate total cost from this price theory, the paper shows how to construct a version of the Keynesian cross diagram. The cross construction suggests an important qualification for fiscal policy, that total cost does not shift. Then, using a neoclassical definition of profit and the total-cost / total-revenue approach, the paper derives aggregate supply, and then adds aggregate demand in an integrated framework. Comparative statics of the AS-AD analysis and the central role of profit in the Treatise suggest that a focus on profit might be useful in identifying exogenous technology shocks of real business cycle theory.     

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.     

Government size and macroeconomic stability: A comment

We show that in a standard, technology shock-driven one-sector real business cycle model, the stabilization effects of government fiscal policy depend crucially on how labor hours enter the household's period utility function and the associated labor-market behavior. In particular, as Galí [European Economic Review 38 (1994), 117-132] has shown, when the household utility is logarithmic in both consumption and leisure, income taxes are destabilizing and government purchases are stabilizing. However, the results are reversed when preferences are instead convex in hours worked. That is, income taxes are now stabilizing and public spending is destabilizing. Furthermore, under both preference specifications, the magnitude of cyclical fluctuations in output remains unchanged when the income tax rate and the share of government purchases in GDP are equal (including laissez-faire).     

Politico-economic inequality and the comovement of government purchases

This paper explores the implications of economic and political inequality for the comovement of government purchases with macroeconomic fluctuations. We set up and compute a heterogeneous-agent neoclassical growth model, where households value government purchases which are financed by income taxes. A key feature of the model is a wealth bias in the political aggregation process. When calibrated to U.S. wealth inequality and exposed to aggregate productivity shocks, such a model is able to generate weaker positive comovement of government purchases than models with no political wealth bias. The wealth bias that matches the cross-sectional campaign contribution distribution by income is consistent with the mild positive comovement of government purchases in the aggregate data. We thus provide an empirically relevant example where economic and political heterogeneity matter for aggregate dynamics.     

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.     

FISCAL STIMULUS WITH LEARNING‐BY‐DOING

Using a Bayesian structural vector autoregression analysis, we document that an increase in government purchases raises private consumption, the real wage, and total factor productivity (TFP) while reducing inflation. These three facts are hard to reconcile with both neoclassical and New Keynesian models. We extend a standard New Keynesian model to allow for skill accumulation through past work experience. An increase in government spending increases hours and induces skill accumulation and higher measured TFP and real wages in subsequent periods. Future marginal costs fall lowering expected inflation and, through the monetary policy rule, the real interest rate. Consumption increases as a result.     

Avoiding pitfalls in using structural VARs to estimate economic models

Structural Vector Autoregressions with a differenced specification of hours (DSVAR) suggest that productivity shocks identified using long-run restrictions lead to a persistent and significant decline in hours worked. Economists have interpreted this evidence as showing that standard business cycle models in which a positive technology shock leads to a rise in hours are inconsistent with the data. In this paper we argue that such a conclusion is unwarranted because model's data and actual data are not treated symmetrically. To illustrate this problem, we estimate and test a flexible-price DSGE model with non-stationary hours using Indirect Inference on impulse responses of hours and output after technology and non-technology shocks. We find that, once augmented with a moderate amount of real frictions, the model can mimic well impulse responses obtained from a DSVAR on actual data. Using this model as a data generating process, we show that our estimation method is less subject to bias than a method that would directly compare theoretical responses with responses from the DSVAR.     

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.