Spending Shocks Research Articles

Are government spending shocks inflationary at the zero lower bound? New evidence from daily data

Are government spending shocks inflationary at the zero lower bound (ZLB)? Despite the importance of the inflation channel in amplifying government spending multipliers at the ZLB, empirical studies have not provided a clear answer to this question. Exploiting newly constructed high-frequency data on government spending and the price index of the U.S. economy, we find that prices decline in response to a positive government spending shock at the ZLB. Government spending shocks are also more deflationary at the ZLB than during normal times. While our finding is difficult to reconcile with standard New Keynesian models, which predict a larger fiscal multiplier following fiscal expansion at the ZLB—driven by rising inflation and a falling real interest rate—a model with credit constraints can explain this anomaly.

The government spending multiplier in the Heterogeneous Agent New Keynesian model

This paper provides an analytical decomposition of the fiscal multiplier in the Heterogeneous Agent New Keynesian model. The derived expression consists of interpretable, model-based channels through which private consumption propagates government spending shocks. The calibrated model is used to estimate the magnitude of multipliers and their structure under alternative fiscal and monetary rules. The derived formula is compared to its representative agent limit to articulate the role of household heterogeneity in the transmission of government spending shocks. A two-agent version of the model is investigated to explore the consequences of cyclical inequality for the propagation of fiscal expenditures.

The distributional effects of government spending shocks in developing economies

AbstractWe construct unanticipated government spending shocks for 103 developing countries from 1990 to 2015 and study their effects on income distribution. We find that unanticipated fiscal consolidations lead to a long‐lasting increase in income inequality, while fiscal expansions lower inequality. The results are robust to several measures of income distribution and size of the fiscal shocks, to an alternative identification strategy, across expansions and recessions and across country groups (low‐income countries vs. emerging markets). An additional contribution of the paper is the computation of the medium‐terminequality multiplier. This is on average about 1 in our sample, meaning that a cumulative decrease in government spending of 1% of gross domestic product over 5 years is associated with a cumulative increase in the Gini coefficient over the same period of about 1 percentage point. The multiplier is larger for total government expenditure than for public investment and consumption (with the former having larger effect), likely due to the redistributive role of transfers. Finally, we find that (unanticipated) fiscal consolidations lead to an increase in poverty.

Fiscal multipliers in advanced and developing countries: Evidence from military spending

This paper provides new evidence on the effects of government spending on output from a large panel of advanced and developing countries. We identify government spending shocks using variation in international military spending. We estimate a one-year fiscal multiplier, pooled across all countries in the sample, in the vicinity of 0.8. The pooled cumulative multiplier reaches its peak at 0.86 two years after the shock. We find substantial heterogeneity across economic environments as well as across countries: The multipliers are relatively large (above one) in advanced economies, in recessions, for negative shocks, under a fixed exchange rate, and in closed economies. We also analyze scenarios in which the identifying restrictions may not hold, highlighting the possible limitations of the military-spending approach and providing a wider range of possible effects.

Mixed Monetary–Fiscal Policies and Macroeconomic Fluctuations: An Analysis Based on the Dynamic Stochastic General Equilibrium Model

AbstractThe existing literature on macroeconomic policy research is mainly concerned with the impact of a single monetary or fiscal policy on China's macroeconomic fluctuations in a closed economy. However, the effect of a mix of monetary and fiscal policies has been neglected. This paper addresses this issue with an open economy dynamic stochastic general equilibrium model. It applies impulse‐response and welfare analyses to explore the stabilization effect of various mixes of monetary and fiscal policies. The results show that the optimal monetary policy and fiscal policy mix varies in different cases. When government spending shocks happen, the aggressive fiscal policy and passive monetary policy would be the best choice. In contrast, for domestic interest rate shocks, foreign interest rate shocks, and foreign consumption shocks, the passive fiscal policy and aggressive monetary policy are more applicable. This article explains China's economic fluctuations and highlights the importance of mix of monetary and fiscal policies in the face of different shocks.

Market segmentation and spending multipliers

When workers are sluggish to change sectors and government demand is concentrated on few sectors, an increase in government spending has limited impact on production in other sectors and multipliers are higher. Compared to a one-sector model, a model calibrated to the 404 sectors of the U.S. economy raises multipliers by 0.5 when preferences feature no wealth effects on labor supply and by more if wealth effects are present. Relative price movements observed in response to spending shocks are consistent with the model’s mechanism. The model suggests that multipliers depend on the composition of stimulus packages.

Local fiscal multipliers of different government spending categories

This paper compares multipliers of different categories of US federal government spending, and in doing so provides a new insight as to why fiscal multipliers may differ across countries and time. We identify exogenous federal government spending shocks at the state level for defense and non-defense spending. Using a projection-based approach, we estimate the cumulative multiplier due to shocks in either of these spending categories. Our results indicate that defense spending yields lower multipliers than non-defense spending. Thus, focusing only on defense spending may result in underestimating the multiplier for government spending.

IS FISCAL POLICY MORE EFFECTIVE DURING RECESSIONS?

AbstractThis article estimates the impact of government spending shocks on economic activity during periods of boom and recession. I estimate these effects using an eclectic approach that employs (i) different strategies to identify exogenous variation in government spending, (ii) different methods to compute dynamic responses, and (iii) different measures of the state of business cycles. I find that government spending shocks have larger impacts on output during expansions than during recessions. Importantly, I explore the reasons why my results differ from other work in the literature and highlight the empirical implications of the information used to define periods of recession.

THE CHANGING STRUCTURE OF GOVERNMENT CONSUMPTION SPENDING

AbstractWe document a secular change in the structure of government consumption spending: Over time the government purchases relatively more private‐sector goods, and relies less on its own production of value added. This process alters the transmission of fiscal policy, by dampening the response of hours, public value added, and the labor share to government spending shocks, while leaving the response of total output unchanged. We rationalize these facts in a general equilibrium model where a decline of the public‐sector relative productivity drives the changing structure of government spending, which in turn modifies the transmission mechanism of government spending shocks.

The Macroeconomic Impact of Fiscal Policy Shocks: What do the Indian Data Say?

This article examines the impact of fiscal policy shocks on a set of macroeconomic variables in India, using a seasonally adjusted quarterly dataset for the period 2003–2019. The Gregory-Hansen residual-based test for cointegration and the vector error correction model (VECM) are applied, and impulse responses based on a recursive identification scheme (Cholesky decomposition) is used to assess the effects of a gross tax revenue shock and a government spending shock on economic activity, while accounting for the possibility of structural breaks. The findings indicate that an unexpected fiscal policy shock has an immediate expansionary impact on real GDP and a sudden positive effect on inflation (WPI) and the repo rate; and that the impact is permanent and away from the zero equilibrium. The careful design of policies by the central bank and the government as crucial macroeconomic stabilisation tools is imperative. JEL Classification: E6, H20, H30

On the relationship between fiscal multipliers and population aging in Japan: Theory and empirics

Recent literature has pointed out that the effect of fiscal policy possibly depends on the aging structure. This paper contributes to the literature by approaching this issue from both empirical and theoretical perspectives. We first examine how population aging affects the efficacy of fiscal stimulus by using panel data from Japan, the world's fastest aging country, and reveal that a government spending shock becomes less effective as the aging rate increases. Then, we construct the theoretical model with heterogeneous agents to replicate our empirical evidence and conduct counterfactual simulation to identify the source of state-dependency. The counterfactual analysis highlights the role of the supply channel through which workers under a liquidity constraint can benefit from increased disposable income induced by a government spending shock. This suggests that promoting labor market participation by elderly people can increase the effectiveness of a government spending shock amid a rapidly aging society.

Households' Balance Sheets and the Effect of Fiscal Policy

AbstractUsing households' balance‐sheet composition in the Panel Survey of Income Dynamics, we identify six household types. Since 1999, there has been a decline in the share of patient households and an increase in the share of impatient households with negative wealth. Using a six‐agent New Keynesian model with search and matching frictions, we explore how changes in households' shares affect the transmission of government spending shocks. We show that the relative share of households in the left tail of the wealth distribution plays a key role in the aggregate marginal propensity to consume, the magnitude of fiscal multipliers, and the distributional consequences of government spending shocks. While the output and consumption multipliers are positively correlated with the share of households with negative wealth, the size of the employment multiplier is negatively correlated. Moreover, our calibrated model can deliver jobless fiscal expansions.

Fiscal Multiplier and the Size of Government Spending Shock. The Case of the U.S

Fiscal Multiplier and the Size of Government Spending Shock. The Case of the U.S

Sectoral Fiscal Multipliers and Technology in Open Economy

Motivated by recent evidence pointing at an increase in the TFP following higher government spending, we explore how technology affects sectoral fiscal multipliers in open economy. Our estimates for eighteen OECD countries over 1970-2015 reveal that a government spending shock increases significantly the non-traded-goods-sector share of total hours worked while the response of the value added share of non-tradables (at constant prices) is muted at all horizon. The latter finding is puzzling as government spending shocks are strongly biased toward non-tradables. Our empirical findings show that the solution to this puzzle lies in technology which responds endogenously to the government spending shock. By offsetting the effect of the biasedness of the demand shock toward non-tradables, the rise in traded relative to non-traded TFP ensures that real GDP growth is uniformly distributed across sectors (i.e., in accordance with their value added share). Because a government spending shock also leads non-traded firms to bias technological change toward labor and traded firms to bias technological change toward capital, factor-augmenting technological change rationalizes the concentration of the rise in labor in the non-traded sector. Our quantitative analysis shows that a semi-small open economy model with tradables and non-tradables can reproduce the sectoral fiscal multipliers we document empirically once we let the decision on technology improvement vary across sectors and allow firms to change the mix of labor- and capital-augmenting efficiency over time.

Are government spending shocks inflationary at the zero lower bound? New evidence from daily data

Are government spending shocks inflationary at the zero lower bound? New evidence from daily data

Using Stock Returns to Identify Government Spending Shocks: New Insights

Using Stock Returns to Identify Government Spending Shocks: New Insights

Countercyclical fiscal policy and gender employment: evidence from the G-7 countries

Abstract Would countercyclical fiscal policy during recessions improve or worsen the gender employment gap? We answer this question by exploring the state-dependent impact of fiscal spending shocks on employment by gender in the G-7 countries. Using the local projection method, we find that, during recessions, a positive fiscal spending shock increases female employment more than male employment, contributing to gender employment equality. Our findings are driven by disproportionate employment changes in female-friendly industries, occupations, and part-time jobs in response to fiscal spending shocks. The analysis suggests that fiscal stimulus, particularly during recessions, could achieve the twin objectives of supporting aggregate demand and improving gender gaps.

Government Spending Shocks and Private Sector Innovation

Government Spending Shocks and Private Sector Innovation

The inflation response to government spending shocks: A fiscal price puzzle?

Standard New Keynesian models predict that expansionary fiscal policy is inflationary. In contrast, this paper presents empirical evidence that prices do not increase in response to a positive government spending shock. Instead, the response of prices is flat or even negative. This finding is robust across a wide range of specifications of our Structural Vector Autoregression (SVAR) model and across different price indices. The puzzling response of prices is accompanied by an increase in output and private consumption, as found in most of the existing literature, as well as an increase in Total Factor Productivity. We show that the introduction of variable technology utilization can enable an otherwise standard New Keynesian model to account for our empirical findings. The model implies that the government spending multiplier is substantially lower when the economy is in a fundamental liquidity trap, as compared to normal times, in contrast to the predictions of standard New Keynesian models.

Fiscal policy shocks and international spillovers

The domestic and international transmission mechanism of fiscal policy shocks are analysed in the United States and in Germany. Using a Bayesian VAR approach, we find that in both of these countries a fiscal expansion is associated with increases in output as well as in private consumption and investment. The terms of trade, which affect the international transmission of fiscal policy shocks, depreciate in response to a fiscal expansion, thus transferring some of the increased domestic purchasing power abroad. A US government spending shock is expansionary for all non-US G7 members. A German government spending shock is expansionary for most, but not all European economies, both within and outside the euro area. The dynamics of the BVAR can be rationalised using a dynamic stochastic general equilibrium model where heterogeneous households and firms face borrowing constraints.