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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. Lawrence J. Christiano & Roberto Motto & Massimo Rostagno, 2014. "Risk Shocks," American Economic Review, American Economic Association, vol. 104(1), pages 27-65, January.
  2. 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.
  3. Francesco Bianchi & Leonardo Melosi, 2013. "Dormant Shocks and Fiscal Virtue," Working Papers 13-12, Duke University, Department of Economics.
  4. Foerster, Andrew T. & Rubio-Ramirez, Juan F. & Waggoner, Daniel F. & Zha, Tao, 2014. "Perturbation methods for Markov-switching DSGE models," Working Paper 2014-16, Federal Reserve Bank of Atlanta.
  5. Nicholas Bloom, 2007. "The Impact of Uncertainty Shocks," NBER Working Papers 13385, National Bureau of Economic Research, Inc.
  6. Troy Davig & Eric M. Leeper, 2005. "Generalizing the Taylor principle," Research Working Paper RWP 05-13, Federal Reserve Bank of Kansas City.
  7. Troy Davig & Eric M. Leeper, 2009. "Monetary-Fiscal Policy Interactions and Fiscal Stimulus," NBER Working Papers 15133, National Bureau of Economic Research, Inc.
  8. Davig, Troy, 2004. "Regime-switching debt and taxation," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 837-859, May.
  9. Roger E.A. Farmer & Daniel F. Waggoner & Tao Zha, 2008. "Minimal state variable solutions to Markov-switching rational expectations models," Working Paper 2008-23, Federal Reserve Bank of Atlanta.
  10. Jaimovich, Nir & Rebelo, Sérgio, 2006. "Can News About the Future Drive the Business Cycle?," CEPR Discussion Papers 5877, C.E.P.R. Discussion Papers.
  11. 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.
  12. Susanto Basu & Brent Bundick, 2011. "Uncertainty Shocks in a Model of Effective Demand," Boston College Working Papers in Economics 774, Boston College Department of Economics, revised 20 Sep 2012.
  13. Hess Chung & Troy Davig & Eric M. Leeper, 2007. "Monetary and Fiscal Policy Switching," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(4), pages 809-842, 06.
  14. Ellen R. McGrattan, 2010. "Capital taxation during the U.S. Great Depression," Staff Report 451, Federal Reserve Bank of Minneapolis.
  15. Hollmayr, Josef & Matthes, Christian, 2013. "Learning about fiscal policy and the effects of policy uncertainty," Discussion Papers 51/2013, Deutsche Bundesbank, Research Centre.
  16. 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.
  17. 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.
  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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