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Identifying the effects of government spending shocks with and without expected reversal: an approach based on U.S. real-time data

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  • Cimadomo, Jacopo
  • Hauptmeier, Sebastian
  • Sola, Sergio

Abstract

This paper investigates how expectations about future government spending affect the transmission of fiscal policy shocks. We study the effects of two different types of government spending shocks in the United States: (i) spending shocks that are accompanied by an expected reversal of public spending growth below trend; (ii) spending shocks that are accompanied by expectations of future spending growth above trend. We use the Ramey (2011)’s time series of military build-ups to measure exogenous spending shocks, and deviations of forecasts of public spending with respect to past trends, evaluated in real-time, to distinguish shocks into these two categories. Based on a structural VAR analysis, our results suggest that shocks associated with an expected spending reversal exert expansionary effects on the economy and accelerate the correction of the initial increase in public debt. Shocks associated with expected spending growth above trend, instead, are characterized by a contraction in aggregate demand and a more persistent increase in public debt. The main channel of transmission seems to run through agents’ perception of the future macroeconomic environment. JEL Classification: E62, E65, H20

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 1361.

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Date of creation: Jul 2011
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Handle: RePEc:ecb:ecbwps:20111361

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Keywords: Fiscal multipliers; Government spending shocks; real-time data; Spending reversal; Survey of Professional Forecasters;

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Cited by:
  1. Jacopo Cimadomo, 2011. "Real-time data and fiscal policy analysis: a survey of the literature," Working Papers 11-25, Federal Reserve Bank of Philadelphia.
  2. Sergio Sola, 2013. "Temporary and Persistent Fiscal Policy Shocks," IHEID Working Papers 06-2013, Economics Section, The Graduate Institute of International Studies.

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