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Chronicle of a War Foretold: The Macroeconomic Effects of Anticipated Defense Spending Shocks

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  • Pappa, Evi
  • Ben Zeev, Nadav

Abstract

We identify US defense news shocks as shocks that best explain future movements in defense spending over a five-year horizon and are orthogonal to current defense spending. Our identified shocks are strongly correlated with the Ramey (2011) news shocks, but explain a larger share of macroeconomic fluctuations and have significant demand effects. Fiscal news induces significant and persistent increases in output, consumption, investment, hours and the interest rate. Standard DSGE models fail to produce such a pattern. We propose a sticky price model with distortionary taxation, variable capital utilization, capital adjustment costs and rule-of-thumb consumers that replicates the empirical findings.

Suggested Citation

  • Pappa, Evi & Ben Zeev, Nadav, 2014. "Chronicle of a War Foretold: The Macroeconomic Effects of Anticipated Defense Spending Shocks," CEPR Discussion Papers 9948, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:9948
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    More about this item

    Keywords

    Defense spending news; Dsge model; Maximum forecast error variance; Svar;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E65 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Studies of Particular Policy Episodes
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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