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Uncertainty and fiscal cliffs

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  • Troy A. Davig
  • Andrew T. Foerster

Abstract

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.

Suggested Citation

  • Troy A. Davig & Andrew T. Foerster, 2014. "Uncertainty and fiscal cliffs," Research Working Paper RWP 14-4, Federal Reserve Bank of Kansas City.
  • Handle: RePEc:fip:fedkrw:rwp14-04
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    References listed on IDEAS

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    Cited by:

    1. Murray, James, 2014. "Fiscal Policy Uncertainty and Its Macroeconomic Consequences," MPRA Paper 57409, University Library of Munich, Germany.
    2. Fotiou, Alexandra & Shen, Wenyi & Yang, Shu-Chun S., 2020. "The fiscal state-dependent effects of capital income tax cuts," Journal of Economic Dynamics and Control, Elsevier, vol. 117(C).
    3. Richter, Alexander W., 2015. "Finite lifetimes, long-term debt and the fiscal limit," Journal of Economic Dynamics and Control, Elsevier, vol. 51(C), pages 180-203.
    4. Richter, Alexander W. & Throckmorton, Nathaniel A., 2015. "The consequences of an unknown debt target," European Economic Review, Elsevier, vol. 78(C), pages 76-96.
    5. Pablo Garcia, 2021. "Learning, expectations and monetary policy," BCL working papers 153, Central Bank of Luxembourg.
    6. Bi, Huixin & Shen, Wenyi & Yang, Shu-Chun S., 2016. "Debt-dependent effects of fiscal expansions," European Economic Review, Elsevier, vol. 88(C), pages 142-157.
    7. Andrew T. Foerster, 2014. "The asymmetric effects of uncertainty," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 5-26.
    8. Kim, Wongi, 2019. "Government spending policy uncertainty and economic activity: US time series evidence," Journal of Macroeconomics, Elsevier, vol. 61(C), pages 1-1.
    9. Hollmayr, Josef, 2018. "Fiscal regimes and the (non)stationarity of debt," Discussion Papers 11/2018, Deutsche Bundesbank.
    10. Ricco, Giovanni & Callegari, Giovanni & Cimadomo, Jacopo, 2014. "Signals from the Government: Policy Uncertainty and the Transmission of Fiscal Shocks," MPRA Paper 56136, University Library of Munich, Germany.
    11. Martha Elena Delgado-Rojas & Hernán Rincón-Castro, 2017. "Incertidumbre acerca de la política fiscal y ciclo económico," Borradores de Economia 1008, Banco de la Republica de Colombia.
    12. Shoag, Daniel & Veuger, Stan, 2016. "Uncertainty and the geography of the great recession," Journal of Monetary Economics, Elsevier, vol. 84(C), pages 84-93.
    13. Caliendo, Frank N. & Guo, Nick L. & Smith, Jason M., 2018. "Policy uncertainty and bank bailouts," Journal of Financial Markets, Elsevier, vol. 39(C), pages 111-125.
    14. Belke, Ansgar & Goemans, Pascal, 2019. "Uncertainty and non-linear macroeconomic effects of fiscal policy in the US: A SEIVAR-based analysis," Ruhr Economic Papers 826, RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
    15. Caliendo, Frank N. & Gorry, Aspen & Slavov, Sita, 2019. "The cost of uncertainty about the timing of Social Security reform," European Economic Review, Elsevier, vol. 118(C), pages 101-125.

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    More about this item

    Keywords

    Fiscal policy; Uncertainty; Distorting taxation;
    All these keywords.

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • F60 - International Economics - - Economic Impacts of Globalization - - - General
    • F62 - International Economics - - Economic Impacts of Globalization - - - Macroeconomic Impacts

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