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Measuring the Effects of Fiscal Policy

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  • Hafedh Bouakez
  • Foued Chihi
  • Michel Normandin

Abstract

Measuring the effects of discretionary fiscal policy is both difficult and controversial, as some explicit or implicit identifying assumptions need to be made to isolate exogenous and unanticipated changes in taxes and government spending. Studies based on structural vector autoregressions typically achieve identification by restricting the contemporaneous interaction of fiscal and non-fiscal variables in a rather arbitrary way. In this paper, we relax those restrictions and identify fiscal policy shocks by exploiting the conditional heteroscedasticity of the structural disturbances. We use this methodology to evaluate the macroeconomic effects of fiscal policy shocks in the U.S. before and after 1979. Our results show substantive differences in the economy’s response to government spending and tax shocks across the two periods. Importantly, we find that increases in public spending are, in general, more effective than tax cuts in stimulating economic activity. A key contribution of this study is to provide a formal test of the identifying restrictions commonly used in the literature.

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Bibliographic Info

Paper provided by CIRPEE in its series Cahiers de recherche with number 1016.

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Date of creation: 2010
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Handle: RePEc:lvl:lacicr:1016

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Keywords: Fiscal policy; Government spending; Taxes; Primary deficit; Structural vector auto-regression; Identification;

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References

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  1. Bouakez, Hafedh & Normandin, Michel, 2010. "Fluctuations in the foreign exchange market: How important are monetary policy shocks?," Journal of International Economics, Elsevier, vol. 81(1), pages 139-153, May.
  2. Karel Mertens & Morten Ravn, 2010. "Empirical Evidence on the Aggregate Effects of Anticipated and Unanticipated U.S. Tax Policy Shocks," NBER Working Papers 16289, National Bureau of Economic Research, Inc.
  3. King, Mervyn & Sentana, Enrique & Wadhwani, Sushil, 1994. "Volatility and Links between National Stock Markets," Econometrica, Econometric Society, vol. 62(4), pages 901-33, July.
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  5. Sentana, E. & Fiorentini, G., 1997. "Identification, Estimation and Testing of Conditionally Heteroskedastic Factor Model," Papers 9709, Centro de Estudios Monetarios Y Financieros-.
  6. Roberto Rigobon & Brian Sack, 2002. "The impact of monetary policy on asset prices," Finance and Economics Discussion Series 2002-4, Board of Governors of the Federal Reserve System (U.S.).
  7. Morten O. Ravn & Stephanie Schmitt-Grohé & Martín Uribe, 2007. "Explaining the Effects of Government Spending Shocks on Consumption and the Real Exchange Rate," NBER Working Papers 13328, National Bureau of Economic Research, Inc.
  8. Karel Mertens & MortenO. Ravn, 2010. "Measuring the Impact of Fiscal Policy in the Face of Anticipation: A Structural VAR Approach," Economic Journal, Royal Economic Society, vol. 120(544), pages 393-413, 05.
  9. Monacelli, Tommaso & Perotti, Roberto, 2008. "Fiscal Policy, Wealth Effects and Markups," CEPR Discussion Papers 7099, C.E.P.R. Discussion Papers.
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  11. Hafedh Bouakez & Nooman Rebei, 2007. "Why does private consumption rise after a government spending shock?," Canadian Journal of Economics, Canadian Economics Association, vol. 40(3), pages 954-979, August.
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  13. Baxter, Marianne & King, Robert G, 1993. "Fiscal Policy in General Equilibrium," American Economic Review, American Economic Association, vol. 83(3), pages 315-34, June.
  14. Andrew Mountford & Harald Uhlig, 2005. "What are the Effects of Fiscal Policy Shocks?," SFB 649 Discussion Papers SFB649DP2005-039, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  15. Craig Burnside & Martin Eichenbaum & Jonas Fisher, 2003. "Fiscal Shocks and Their Consequences," NBER Working Papers 9772, National Bureau of Economic Research, Inc.
  16. Dotsey, Michael, 1994. "Some unpleasant supply side arithmetic," Journal of Monetary Economics, Elsevier, vol. 33(3), pages 507-524, June.
  17. Christopher A. Sims & Tao Zha, 1995. "Error bands for impulse responses," Working Paper 95-6, Federal Reserve Bank of Atlanta.
  18. Olivier Blanchard & Roberto Perotti, 1999. "An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output," NBER Working Papers 7269, National Bureau of Economic Research, Inc.
  19. Normandin, Michel & Phaneuf, Louis, 2004. "Monetary policy shocks:: Testing identification conditions under time-varying conditional volatility," Journal of Monetary Economics, Elsevier, vol. 51(6), pages 1217-1243, September.
  20. Susan Yang, Shu-Chun, 2005. "Quantifying tax effects under policy foresight," Journal of Monetary Economics, Elsevier, vol. 52(8), pages 1557-1568, November.
  21. Barro, Robert J., 1974. "Are Government Bonds Net Wealth?," Scholarly Articles 3451399, Harvard University Department of Economics.
  22. Andrews, Donald W K & Ploberger, Werner, 1994. "Optimal Tests When a Nuisance Parameter Is Present Only under the Alternative," Econometrica, Econometric Society, vol. 62(6), pages 1383-1414, November.
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Cited by:
  1. Francisco de Castro & Daniel Garrote, 2012. "The effects of fiscal shocks on the exchange rate in the EMU and differences with the US," Banco de Espa�a Working Papers 1224, Banco de Espa�a.
  2. Bouakez, Hafedh & Chihi, Foued & Normandin, Michel, 2014. "Fiscal policy and external adjustment: New evidence," Journal of International Money and Finance, Elsevier, vol. 40(C), pages 1-20.

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