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Estimating the effects of fiscal policy under the budget constraint

  • Peter Claeys

    ()

    (Faculty of Economics, University of Barcelona.)

I reconsider the short-term effects of fiscal policy when both government spending and taxes are allowed to respond to the level of public debt. I embed the long-term government budget constraint in a VAR, and apply this common trends model to US quarterly data. The results overturn some widely held beliefs on fiscal policy effects. The main finding is that expansionary fiscal policy has contractionary effects on output and inflation. Ricardian effects may dominate when fiscal expansions are expected to be adjusted by future tax rises or spending cuts. The evidence supports RBC models with distortionary taxation. We can discard some alternative interpretations that are based on monetary policy reactions or supply-side effects.

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File URL: http://www.ub.edu/irea/working_papers/2007/200715.pdf
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Paper provided by University of Barcelona, Research Institute of Applied Economics in its series IREA Working Papers with number 200715.

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Length: 45 pages
Date of creation: Jul 2007
Date of revision: Jul 2007
Handle: RePEc:ira:wpaper:200715
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