Government Expenditures and Business Cycles—Policy Reaction and Surprise Shocks

Abstract

This article analyses the effects of government expenditures on German business cycle fluctuations by means of an estimated DSGE model based on low frequency oscillations. The results highlight that fiscal policy has a strong impact on the amplitude of fluctuations while hardly any on the duration of business cycles. To the extent that fiscal policy shocks are an important source for triggering economy-wide fluctuations, fiscal policy also strongly reacts to shocks originating elsewhere. Thus standard specifications of government expenditures in terms of simple AR(1) processes ignore the fact that there can indeed be a strong dependence of governmental variables on economic fluctuations. JEL Classification: C13, C32, E3, E62