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Cyclicality of Fiscal Policy: Permanent and Transitory Shocks

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Author Info
Strawczynski, Michel
Zeira, Joseph

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Abstract

This paper examines the optimal reaction of fiscal policy to permanent and transitory shocks to output in a model of tax and public consumption smoothing. The model predicts that optimal reaction of public expenditures and deficits to transitory shocks should be countercyclical, while optimal reaction to permanent shocks should be a-cyclical. Using the Blanchard and Quah (1989) methodology for identifying permanent and transitory shocks, we test these predictions for a sample of 22 OECD countries over the years 1963-2006. We find that both expenditures and deficits are countercyclical to transitory shocks, mainly through public transfers and mainly in recessions. We find that government investment is pro-cyclical with respect to permanent shocks, but total expenditures are not.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7271.

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Date of creation: Apr 2009
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Handle: RePEc:cpr:ceprdp:7271

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Related research
Keywords: Business Cycles; Fiscal Policy; Permanent and Transitory Shocks;

Find related papers by JEL classification:
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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  2. Adriana Arreaza & Bent E. Sgrensen & Oved Yosha, 1999. "Consumption Smoothing through Fiscal Policy in OECD and EU Countries," NBER Chapters, in: Fiscal Institutions and Fiscal Performance, pages 59-80 National Bureau of Economic Research, Inc. [Downloadable!]
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    Other versions:
  4. Golinelli, Roberto & Momigliano, Sandro, 2006. "Real-time determinants of fiscal policies in the euro area," Journal of Policy Modeling, Elsevier, vol. 28(9), pages 943-964, December. [Downloadable!] (restricted)
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  8. Fiorito, Riccardo & Kollintzas, Tryphon, 1994. "Stylized facts of business cycles in the G7 from a real business cycles perspective," European Economic Review, Elsevier, vol. 38(2), pages 235-269, February. [Downloadable!] (restricted)
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  10. Ana Lamo & Javier J. Pérez & Ludger Schuknecht, 2007. "The cyclicality of consumption, wages and employment of the public sector in the euro area," Working Paper Series 757, European Central Bank. [Downloadable!]
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