Fiscal Policy Shocks Research Articles

What are the Effects of Fiscal Policy Shocks?

We propose and apply a new approach for analyzing the effects of fiscal policy using vector autoregressions. Specifically, we use sign restrictions to identify a government revenue shock as well as a government spending shock, while controlling for a generic business cycle shock and a monetary policy shock. We explicitly allow for the possibility of announcement effects, i.e., that a current fiscal policy shock changes fiscal policy variables in the future, but not at present. We construct the impulse responses to three linear combinations of these fiscal shocks, corresponding to the three scenarios of deficit-spending, deficit-financed tax cuts and a balanced budget spending expansion. We apply the method to US quarterly data from 1955-2000. We find that deficit-financed tax cuts work best among these three scenarios to improve GDP, with a maximal present value multiplier of five dollars of total additional GDP per each dollar of the total cut in government revenue five years after the shock.

Fiscal Shocks and Policy Regimes in Some OECD Countries

The objective of this paper is twofold. First, for some OECD countries we econometrically select the fiscal policy regimes, i.e. a "set of rules" for the conduct of fiscal policy. Second, we identify different types of fiscal policy shocks related to expenditure and taxation, and simulate their effects on GDP and the price level. Estimation and simulation are obtained within the structural VAR framework. We found that France and Italy are characterized by fiscal regimes that target either the government expenditure on salaries and transfers, or the residual spending. For Germany and the US instead the selected fiscal regimes exclude any (contemporaneous) influence of innovations in government wages and transfers on both taxation and residual spending, i.e. decisions on government wages and transfers do not precede other fiscal-policy decisions. Except for France, government expenditure on salaries and transfers has the strongest procyclical effect on output, but lower than expected: a one percent decrease in public spending on wages and transfers (as a ratio of GDP) lowers output at most by 0.1 percent. Innovations on taxes that decrease fiscal pressure have the standard positive effect on output, but not in the long run.

Time to enter and business cycles

This paper examines a model in which market entry forms a business cycle propagation mechanism. During expansionary periods, new firms enter previously monopolized markets creating efficiency gains that amplify the effect of technology and fiscal policy shocks on employment. Market entry is delayed creating a dynamic pattern to output growth closer to that observed in the US economy than the standard RBC model.

Fiscal consolidation under fixed exchange rates

We present the ‘fixed exchange rate’ version of the Obstfeld and Rogoff model and analyze the international transmission of fiscal policy shocks. The welfare effects of an unanticipated contraction in government expenditure in the home country are shown to depend crucially on the way in which world money stock is set. If home authorities alone are responsible for pegging the exchange rate, a fiscal adjustment leads to a decrease in the real interest rate, stimulates private consumption and limits the contraction in world output, compared with a situation in which a cooperative scheme is implemented. The model is then used to propose a new interpretation of recent events in the EU countries that have enacted restrictive fiscal policies while pegging their currencies to the DM.

Monetary and Fiscal Policy Dynamics in an Asymmetric Monetary Union

This paper investigates the dynamic effects of monetary and fiscal policy in a monetary union, which is characterized by asymmetric interest rate transmission. This asymmetry gives rise to intertemporal reversals in the relative effectiveness of policy on member country outputs. The direction and the number of these reversals depend on whether policies are unanticipated or anticipated. We also study the coordination between monetary and fiscal policy in a monetary union. Monetary policy may completely stabilize European output after unanticipated fiscal policy shocks. With anticipated fiscal policy shocks, complete stabilization throughout the overall adjustment process requires monetary policy to be time-inconsistent.

The Relationship between Real Wages and Output: Evidence from Pakistan

Information on wage levels is essential in evaluating the living standards and conditions of work and life of the workers. Since nominal wage fails to explain the purchasing power of employees, real wage is considered as a major indicator of employees purchasing power and can be used as proxy for their level of income. Any fluctuations in the real wage rate have a significant impact on poverty and the distribution of income. When used in relation with other economic variables, for instance employment or output they are valuable indicators in the analysis of business cycles. There has been a long debate regarding the relationship between real wages and the employment (output). Despite the apparent simplicity, the relationship between real wages and output has remained deceptive both theoretically and empirically. Keynes (1936) viewed cyclical movements in employment along a stable labour demand schedule thus indicating counter cyclical real wages. His deduction is in line with sticky wages and sticky expectations, which augments models like Phillips curve. In these models real wages behaved as counter-cyclical as nominal wages are slow to adjust during recession (decrease in aggregate demand and associated slowdown in price growth). Stickiness of wages or expectations shifts the labour supply over the business cycles [Abraham and Haltiwanger (1995)]. Barro (1990) and Christiano and Eichenbaum (1992) have associated these labour supply shifts with intertemporal labour-leisure substitution. This in response to temporary changes in real interest rates (fiscal policy shocks) could yield counter-cyclical real wages. However, Long and Plosser (1983) and Kydland and Prescott (1982) while studying the real business cycle models highlight on the technology shocks which leads to pro-cyclical real wages.

Openness and growth: an interpretation of empirical evidence from East Asian countries

This study investigates the effect of openness on economic growth for rapidly growing economies in East Asia in which rapid growth has been accompanied by a persistent openness to world trade. The framework of analysis is a five-variable vector autoregressive model that consists of real output, money supply, real government spending, foreign price shocks, and openness measures. The results do not strongly support the 'new' growth theories in which increasing openness affects long-run growth. For most countries in the sample, fiscal policy shocks as well as foreign price shocks have greater impacts on economic growth than does the openness shock. The results are generally consistent with the view that the role of the government is critical for growth among the East Asian economies.

Demand-Side Stabilization Policies: What is the Evidence of Their Potential?

Using disaggregated data for the United States, this paper explores the effects of the variability of fiscal and monetary policy shocks. Higher variability of government spending shocks around a steady-state growth trend results, on average, in a decline in aggregate demand growth and inflation, with limited effects on output growth. On the other hand, higher variability of monetary shocks results, on average, in an increase in inflation and a decline in output growth. These results indicate the desirability of avoiding large fluctuations over time in either government spending or the money supply.

Demand-Side Stabilization Policies: What is the Evidence of Their Potential?

Using disaggregated data for the United States, this paper explores the effects of the variability of fiscal and monetary policy shocks. Higher variability of government spending shocks around a steady-state growth trend results, on average, in a decline in aggregate demand growth and inflation, with limited effects on output growth. On the other hand, higher variability of monetary shocks results, on average, in an increase in inflation and a decline in output growth. These results indicate the desirability of avoiding large fluctuations over time in either government spending or the money supply.

Demand-Side Stabilization Policies: What is the Evidence of their Potential?

Using disaggregated data for the United States, this paper explores the effects of the variability of fiscal and monetary policy shocks. Higher variability of government spending shocks around a steady-state growth trend results, on average, in a decline in aggregate demand growth and inflation, with limited effects on output growth. On the other hand, higher variability of monetary shocks results, on average, in an increase in inflation and a decline in output growth. These results indicate the desirability of avoiding large fluctuations over time in either government spending or the money supply.

Life-Cycles, Dynasties, Saving: Implications for Closed and Small, Open Economies

This paper examines the macroeconomic implications of life-cycle and dynastic saving behavior for closed and small, open economies. Using an extended version of Blanchard`s overlapping agents model, the analytical framework nests these two competing views, treating agents as either dynastic households or disconnected generations. Calibrating the life-cycle variant using empirical age-earnings profiles, the analysis compares the long-run effects of fiscal policy shocks under both perspectives. The results quantify the implications of life-cycle considerations for the effects of deficit finance on real interest rates and the capital stock or net foreign assets.

Life-Cycles, Dynasties, Savings: Implications for Closed and Small, Open Economies

This paper examines the macroeconomic implications of life-cycle and dynastic saving behavior for closed and small, open economies. Using an extended version of Blanchard’s overlapping agents model, the analytical framework nests these two competing views, treating agents as either dynastic households or disconnected generations. Calibrating the life-cycle variant using empirical age-earnings profiles, the analysis compares the long-run effects of fiscal policy shocks under both perspectives. The results quantify the implications of life-cycle considerations for the effects of deficit finance on real interest rates and the capital stock or net foreign assets.

Policy Shocks in a Monetary Asset-Pricing Model with Endogenous Production / Politikeffekte in einem monetären Asset-Pricing-Modell mit Produktion

Summary In a framework of a monetary asset pricing model with production the effects of monetary and fiscal policy shocks are investigated. The model is kept simple enough to generate explicit formulae for the equilibrium price functions. With money yielding liquidity services in the exchange process real stock prices are negatively correlated with stochastic fiscal policy changes, while the impact of structural fiscal policy on the stock market depends on the level of private consumption in the economy. Moreover, shares provide protection against inflation from monetary shocks, and a suitably chosen structural fiscal policy can be used to achieve a stabilization of the real rates of return of both assets.

The Term Structure of Interest Rates and the Effects of Macroeconomic Policy

This paper analyzes the effects of monetary and fiscal policy shocks on the term structure of interest rates. The effects of temporary versus permanent, unanticipated versus anticipated, policy disturbances and the responses of long versus short, and real versus nominal, rates are contrasted. The main results are summarized in a series of propositions. Among them, the finding that an unanticipated permanent fiscal expansion impacts more on long-term rates, may help explain their observed excessive volatility. The effects of structural changes on the relative variances are also discussed, with the effect which operates through the impact on private speculative behavior being emphasized.

Fiscal deficits and relative prices in a growing world economy

This paper studies the transmission of fiscal disturbances between countries and the effect of those disturbances on worldwide capital intensity in a context of growth. The model developed to address these issues allows for the production of both nontradable and relatively capital-intensive tradable goods; a central finding is that factor markets can be a major channel for the communication of fiscal policy shocks to world interest rates, to private saving decisions, and, ultimately, to global asset supplies and their distribution among countries. Particular predictions of the model illustrate how changes in public debt ratios and shifts in government spending patterns affect resource allocation and the welfare of various generations, both at home and abroad.

Modelling Anticipated and Temporary Fiscal Policy Shocks in a Macro-Econometric Model of Canada

Following the work of Ray Fair (1979), expectations terms in the FOCUS model are generated using predicted values from the model itself. Expectations are therefore consistent with the model struct ured. Government expenditure multipliers are compared for the standar d model and the CE version. Three further examples show the power of the technique as applied to the analysis of fiscal policy shocks. T he first considers a temporary versus a permanent income tax surcharg e. The second considers the possibility of an anticipatory recession when preannounced fiscal stimulus is combined with monetary restrai nt. The third examines the planned restructuring of the Canadian corp orate tax system.

THE EFFECT OF FISCAL POLICY ON THE SHORT‐RUN RELATION BETWEEN NOMINAL INTEREST RATES AND INFLATION

This paper presents a simple empirical model of the relation between the inflation rate and the nominal interest rate. We show that previous results found in the literature may be attributed to specification error and that there are natural explanations for the observed signs of previous Fisher equation estimates. Our results show that fiscal policy shocks may generate short run negative correlations between changes in inflation and changes in the nominal interest rates. These results illustrate the difficulty in discussing the relation between inflation and nominal interest rates without conditioning the analysis with specific assumptions on the course of the economy.