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Fiscal Volatility Shocks and Economic Activity

  • Jesus Fernandez-Villaverde

    ()

    (Department of Economics, University of Pennsylvania)

  • Pablo Guerron-Quintana

    ()

    (Federal Reserve Bank of Philadelphia)

  • Keith Kuester

    ()

    (Federal Reserve Bank of Philadelphia)

  • Juan Rubio-Ramirez

    ()

    (Department of Economics, Duke University)

We study the effects of changes in uncertainty about future fiscal policy on aggregate economic activity. Fiscal deficits and public debt have risen sharply in the wake of the financial crisis. While these developments make fisscal consolidation inevitable, there is considerable uncertainty about the policy mix and timing of such budgetary adjustment. To evaluate the consequences of this increased uncertainty, we first estimate tax and spending processes for the U.S. that allow for time-varying volatility. We then feed these processes into an otherwise standard New Keynesian business cycle model calibrated to the U.S. economy. We find that fiscal volatility shocks have an adverse effect on economic activity that is comparable to the effects of a 25-basis-point innovation in the federal funds rate.

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Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 11-022.

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Length: 47 pages
Date of creation: 09 Aug 2011
Handle: RePEc:pen:papers:11-022
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