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Is Government Spending Predetermined? A Test of Identification for Fiscal Policy Shocks

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  • Anna Kormilitsina

    (Southern Methodist University)

Abstract

Strategies to identify fiscal policies and their effects often use an idea that fiscal instruments cannot respond to realizations of macroeconomic uncertainties within one quarter. I evaluate the validity of this assumption in a standard estimated DSGE model, where informational subperiods are introduced to ensure fiscal policy choices are made before the current state of economy realizes. At the same time, fiscal instruments are allowed to partially respond to macroeconomic shocks, and these responses are estimated using the Bayesian method. The resulting estimates indicate that within one quarter, government spending is adjusted in response to the neutral technology shock, and the tax rate responds to realizations of the preference shock. Moreover, the model capturing contemporaneous responses of fiscal instruments to shocks provides a better fit to the data than the model where fiscal variables are completely predetermined. These results suggest that treating fiscal instruments as predetermined is misleading. Instead of identifying fiscal shocks, such a strategy identifies a combination of the shocks and other macroeconomic uncertainties. I demonstrate that the positive consumption response to the government spending shock in a Cholesky identified structural VAR model reflects the response to the technology shock, while the consumption response is negative in the estimated model.

Suggested Citation

  • Anna Kormilitsina, 2016. "Is Government Spending Predetermined? A Test of Identification for Fiscal Policy Shocks," Departmental Working Papers 1607, Southern Methodist University, Department of Economics.
  • Handle: RePEc:smu:ecowpa:1607
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    References listed on IDEAS

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    1. Patrick F?ve & Julien Matheron & Jean-Guillaume Sahuc, 2013. "A Pitfall with Estimated DSGE-Based Government Spending Multipliers," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(4), pages 141-178, October.
    2. Anna Kormilitsina, 2013. "Solving Rational Expectations Models with Informational Subperiods: A Perturbation Approach," Computational Economics, Springer;Society for Computational Economics, vol. 41(4), pages 525-555, April.
    3. Anna Kormilitsina & Sarah Zubairy, 2018. "Propagation Mechanisms for Government Spending Shocks: A Bayesian Comparison," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 50(7), pages 1571-1616, October.
    4. Ryan Chahrour & Stephanie Schmitt-Grohé & Martín Uribe, 2012. "A Model-Based Evaluation of the Debate on the Size of the Tax Multiplier," American Economic Journal: Economic Policy, American Economic Association, vol. 4(2), pages 28-45, May.
    5. Hafedh Bouakez & Nooman Rebei, 2007. "Why does private consumption rise after a government spending shock?," Canadian Journal of Economics, Canadian Economics Association, vol. 40(3), pages 954-979, August.
    6. JonasD.M. Fisher & Ryan Peters, 2010. "Using Stock Returns to Identify Government Spending Shocks," Economic Journal, Royal Economic Society, vol. 120(544), pages 414-436, May.
    7. Patrick Fève & Julien Matheron & Jean-Guillaume Sahuc, 2011. "A Pitfall with DSGE–Based, Estimated, Government Spending Multipliers," 2011 Meeting Papers 136, Society for Economic Dynamics.
    8. Ludger Linnemann & Andreas Schabert, 2006. "Productive Government Expenditure In Monetary Business Cycle Models," Scottish Journal of Political Economy, Scottish Economic Society, vol. 53(1), pages 28-46, February.
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    Cited by:

    1. Anna Kormilitsina & Sarah Zubairy, 2018. "Propagation Mechanisms for Government Spending Shocks: A Bayesian Comparison," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 50(7), pages 1571-1616, October.

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    More about this item

    Keywords

    Government spending shocks; DSGE model estimation; Timing; Informational subperiods;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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