Abstract
We investigate state‐dependent effects of fiscal multipliers and allow for endogenous sample splitting to determine whether the U.S. economy is in a slack state. When the endogenized slack state is estimated as the period of the unemployment rate higher than about 12%, the estimated cumulative multipliers are significantly larger during slack periods than nonslack periods and are above unity. We also examine the possibility of time‐varying regimes of slackness and find that our empirical results are robust under a more flexible framework. Our estimation results point out the importance of the heterogenous effects of fiscal policy and shed light on the prospect of fiscal policy in response to economic shocks from the current COVID‐19 pandemic. (JEL C32, E62, H20, H62)
Highlights
The debate over the role of fiscal policy during a recession has recently taken center stage again in macroeconomics
In Ramey and Zubairy (2018), the baseline results assume that the US economy is in a slack state if the unemployment rate is above 6.5 percent
We have investigated state-dependent effects of fiscal multipliers and have found that it is crucial how to determine whether the US economy is in a slack state
Summary
The debate over the role of fiscal policy during a recession has recently taken center stage again in macroeconomics. In Ramey and Zubairy (2018), the baseline results assume that the US economy is in a slack state if the unemployment rate is above 6.5 percent. It turns out that the endogenized threshold level of the unemployment rate is estimated at 11.97 percent, which is much higher than 6.5 percent adopted in Ramey and Zubairy (2018). The threshold regression model above provides a natural way to endogenize the level of slackness since there is a change point at τ for GDP in the model To estimate this model, it is necessary to specify the parameter space for τ. We set it to be the interval between the 5 and 95 percentiles of the unemployment rates
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