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Uncertainty and fiscal cliffs

  • Davig, Troy A.

    ()

    (Federal Reserve Bank of Kansas City)

  • Foerster, Andrew T.

    (Federal Reserve Bank of Kansas City)

Motivated by the US Fiscal Cliff in 2012, this paper considers the short- and longer- term impact of uncertainty generated by fiscal policy. Empirical evidence shows increases in economic policy uncertainty lower investment and employment. Investment that is longer-lived and subject to a longer planning horizon responds to policy uncertainty with a lag, while capital that depreciates more quickly and can be installed with few costs falls immediately. A DSGE model incorporating uncertainty over future tax regimes produces responses to fiscal uncertainty that match key features of the data. The model features uncertainty over the average tax rate and rational expectations about the resolution of uncertainty with specific outcomes and timing. Uncertainty injects noise into the economy and lowers the level of economic activity.

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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 14-4.

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Length: 32 pages
Date of creation: 01 Apr 2014
Date of revision:
Handle: RePEc:fip:fedkrw:rwp14-04
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  1. Foerster, Andrew & Rubio-Ramírez, Juan & Waggoner, Daniel F. & Zha, Tao, 2013. "Perturbation methods for Markov-switching DSGE models," Working Paper 2013-01, Federal Reserve Bank of Atlanta.
  2. Born, Benjamin & Peter, Alexandra & Pfeifer, Johannes, 2013. "Fiscal news and macroeconomic volatility," Journal of Economic Dynamics and Control, Elsevier, vol. 37(12), pages 2582-2601.
  3. Susanto Basu & Brent Bundick, 2012. "Uncertainty shocks in a model of effective demand," Working Papers 12-15, Federal Reserve Bank of Boston.
  4. Hess Chung & Troy Davig & Eric Leeper, 2004. "Monetary and Fiscal Policy Switching," Computing in Economics and Finance 2004 325, Society for Computational Economics.
  5. Ellen R. McGrattan, 2010. "Capital Taxation During the U.S. Great Depression," NBER Working Papers 16588, National Bureau of Economic Research, Inc.
  6. Francesco Bianchi & Leonardo Melosi, 2013. "Dormant Shocks and Fiscal Virtue," Working Papers 13-12, Duke University, Department of Economics.
  7. Troy Davig & Eric M. Leeper, 2005. "Generalizing the Taylor Principle," NBER Working Papers 11874, National Bureau of Economic Research, Inc.
  8. Hollmayr, Josef & Matthes, Christian, 2013. "Learning about fiscal policy and the effects of policy uncertainty," Discussion Papers 51/2013, Deutsche Bundesbank, Research Centre.
  9. Nir Jaimovich & Sergio Rebelo, 2006. "Can News About the Future Drive the Business Cycle?," NBER Working Papers 12537, National Bureau of Economic Research, Inc.
  10. Nicholas Bloom, 2009. "The Impact of Uncertainty Shocks," Econometrica, Econometric Society, vol. 77(3), pages 623-685, 05.
  11. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-17, June.
  12. Farmer, Roger E.A. & Waggoner, Daniel F. & Zha, Tao, 2011. "Minimal state variable solutions to Markov-switching rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 35(12), pages 2150-2166.
  13. Troy Davig & Eric Leeper, 2009. "Monetary-Fiscal Policy Interactions And Fiscal Stimulus," Caepr Working Papers 2009-010, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
  14. Christopher L. House & Matthew D. Shapiro, 2008. "Temporary Investment Tax Incentives: Theory with Evidence from Bonus Depreciation," American Economic Review, American Economic Association, vol. 98(3), pages 737-68, June.
  15. Davig, Troy, 2004. "Regime-switching debt and taxation," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 837-859, May.
  16. Lawrence J. Christiano & Roberto Motto & Massimo Rostagno, 2014. "Risk Shocks," American Economic Review, American Economic Association, vol. 104(1), pages 27-65, January.
  17. Francesco Bianchi, 2012. "Evolving Monetary/Fiscal Policy Mix in the United States," American Economic Review, American Economic Association, vol. 102(3), pages 167-72, May.
  18. Alexander W. Richter & Nathaniel A. Throckmorton, 2013. "The Consequences of Uncertain Debt Targets," Auburn Economics Working Paper Series auwp2013-18, Department of Economics, Auburn University.
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