Macroelasticities and the U.S. Sequestration Budget Cuts

Abstract

Microeconomic studies keep reporting that the intertemporal substitution in consumption and the Frisch elasticity of aggregate labor supply have significantly lower values than macroeconomic models find consistent with the dynamics of aggregate variables. The paper argues that in the U.S. such dynamics have been influenced since 2013 by the temporary spending cuts imposed by the so-called budget sequestration. The paper exploits the policy experiment features of that measure to gauge macroelasticity values from the evidence associated with it, adopting to that effect a macroeconomic model constructed according to the methodological principles advocated by the real business cycle literature. Readings of the preliminary evidence available at the time of this writing with such a measuring device do not particularly favor high values for either of the two macroelasticities under study. Although it’s too early to be conclusive, this finding illustrates how existing disagreements about the value of key macroelasticities can eventually be narrowed down by applying the approach proposed in this paper to the evidence coming out of the budget sequestration policy, as it unfolds over time. JEL Classification: E22, E24, E32, E65, J22. ∗The views expressed herein do not necessarily reflect those of the Federal Reserve Bank of Dallas, or the Federal Reserve System. Alan Armen provided superb research assistance. An earlier version of the paper was presented at the Spring 2014 Midwest Macroeconomics Conference and at the 2014 North American Summer Meeting of the Econometric Society. The paper benefited from comments received therein from Alexis Anagnostopoulos, Alexander Richter, Don Schlagenhauf, and Nathaniel Throckmorton. †E-mail: carlos.zarazaga@dal.frb.org. Address: Federal Reserve Bank of Dallas, Research Department, 2200 N. Pearl St., Dallas, TX 75201.