Fiscal Policy Uncertainty and Its Macroeconomic Consequences

I examine fiscal policy uncertainty in a context where market participants learn about the conduct of fiscal policy with regression rules for dependent variables including tax revenue, net transfers, government spending, and government debt. The explanatory variables include lagged fiscal policy, lagged government debt, and macroeconomic outcomes including real GDP, consumption, investment, and the unemployment rate. They re-run these regressions each quarter as a new observation becomes available, updating their understanding of the conduct of fiscal policy. I use the root mean squared errors as measures for fiscal policy uncertainty. I use autoregressive distributed lag (ARDL) models to estimate the effect fiscal uncertainty has on macroeconomic outcomes including real GDP, consumption, investment and unemployment. I find that the common component for fiscal policy uncertainty has adverse effects on real GDP, consumption, and investment. I find the buildup of fiscal policy uncertainty from 2005 through 2009 leads to a decline in real GDP growth by about 2 percentage points. I demonstrate that these finding are robust to lag specifications for the ARDL models and parameter specifications for the learning process.