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A Bayesian approach to estimating tax and spending multipliers

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  • Matthew Denes
  • Gauti B. Eggertsson

Abstract

This paper outlines a simple Bayesian methodology for estimating tax and spending multipliers in a dynamic stochastic general equilibrium (DSGE) model. After forming priors about the parameters of the model and the relevant shock, we used the model to exactly match only one data point: the trough of the Great Depression, that is, an output collapse of 30 percent, deflation of 10 percent, and a zero short-term nominal interest rate. Because we form our priors as distributions, the key economic inference of our analysis--the multipliers of tax and spending--are well-defined probability distributions derived from the posterior of the model. While the Bayesian methods used are standard, the application is slightly unusual. We conjecture that this methodology can be applied in several different settings with severe data limitations and where more informal calibrations have been the norm. The main advantage over usual calibration exercises is that the posterior of the model offers an interesting way to think about sensitivity analysis and gives researchers a useful way to describe model-based inference. We apply our simple estimation method to the American Recovery and Reinvestment Act (ARRA), passed by Congress as part of the 2009 stimulus plan. The mean of our estimate indicates that ARRA increased output by 3.6 percent in 2009 and 2010. The standard deviation of this estimate is 1 percent.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 403.

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Date of creation: 2009
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Handle: RePEc:fip:fednsr:403

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Related research

Keywords: Depressions ; Econometric models ; Taxation ; Government spending policy;

This paper has been announced in the following NEP Reports:

References

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  1. Gauti B. Eggertsson, 2007. "Was the New Deal Contractionary?," 2007 Meeting Papers 660, Society for Economic Dynamics.
  2. An, Sungbae & Schorfheide, Frank, 2005. "Bayesian Analysis of DSGE Models," CEPR Discussion Papers 5207, C.E.P.R. Discussion Papers.
  3. Gauti B. Eggertsson, 2009. "What fiscal policy is effective at zero interest rates?," Staff Reports 402, Federal Reserve Bank of New York.
  4. Gauti B. Eggertsson, 2011. "Fiscal Multipliers and Policy Coordination," Working Papers Central Bank of Chile 628, Central Bank of Chile.
  5. Cogan, John F. & Cwik, Tobias J. & Taylor, John B. & Wieland, Volker, 2009. "New Keynesian versus old Keynesian government spending multipliers," CFS Working Paper Series 2009/17, Center for Financial Studies (CFS).
  6. Gauti B. Eggertsson, 2008. "Great Expectations and the End of the Depression," American Economic Review, American Economic Association, vol. 98(4), pages 1476-1516, September.
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Cited by:
  1. Kaszab, Lorant, 2011. "Fiscal Policy Multipliers in a New Keynesian Model under Positive and Zero Nominal Interest Rate," Cardiff Economics Working Papers E2011/11, Cardiff University, Cardiff Business School, Economics Section.
  2. Shu-Chun S. Yang & Todd B. Walker & Eric M. Leeper, 2010. "Government Investment and Fiscal Stimulus," IMF Working Papers 10/229, International Monetary Fund.
  3. Michael Woodford, 2010. "Optimal Monetary Stabilization Policy," Discussion Papers 0910-18, Columbia University, Department of Economics.

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