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When Do Discretionary Changes in Government Spending or Taxes Have Larger Effects?

Listed author(s):
  • Steven M. Fazzari

    ()

    (Washington University in St. Louis)

  • James Morley

    ()

    (University of New South Wales)

  • Irina B. Panovska

    ()

    (Lehigh University)

We investigate when discretionary increases and decreases in government spending or taxes have larger effects using a nonlinear vector autoregressive model with fiscal shocks identified via sign restrictions. We confirm previous empirical findings of state dependence in the relationship between fiscal policy and aggregate output, with the nonlinearity related to a broad measure of economic slack that displays strong asymmetry across the business cycle. This state dependence has important implications for the timing of stimulus or austerity measures. We find that tax cuts and spending increases have similarly large stimulative effects in periods of excessive slack, but are much less effective, especially in the case of spending increases, when the economy is close to or above potential. In terms of austerity measures designed to reduce the debt-to-GDP ratio, we find that tax increases and spending cuts are most contractionary and largely self defeating in periods of excessive slack, while only spending cuts lead to any significant reduction in the debt-to-GDP ratio when the economy is close to or above potential. The effectiveness of discretionary spending, including its state dependence, appears to be due almost entirely to the response of aggregate consumption, while the responses of both consumption and investment to discretionary taxes are state dependent, but investment appears to play the larger role in terms of their effectiveness.

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File URL: http://research.economics.unsw.edu.au/RePEc/papers/2017-04.pdf
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Paper provided by School of Economics, The University of New South Wales in its series Discussion Papers with number 2017-04.

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Length: 65 pages
Date of creation: Feb 2017
Handle: RePEc:swe:wpaper:2017-04
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  1. Perron, Pierre & Wada, Tatsuma, 2009. "Let's take a break: Trends and cycles in US real GDP," Journal of Monetary Economics, Elsevier, vol. 56(6), pages 749-765, September.
  2. Orphanides, Athanasios & van Norden, Simon, 2005. "The Reliability of Inflation Forecasts Based on Output Gap Estimates in Real Time," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(3), pages 583-601, June.
  3. Baum, Anja & Koester, Gerrit B., 2011. "The impact of fiscal policy on economic activity over the business cycle - evidence from a threshold VAR analysis," Discussion Paper Series 1: Economic Studies 2011,03, Deutsche Bundesbank, Research Centre.
  4. Silvana Tenreyro & Gregory Thwaites, 2016. "Pushing on a String: US Monetary Policy Is Less Powerful in Recessions," American Economic Journal: Macroeconomics, American Economic Association, vol. 8(4), pages 43-74, October.
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  7. Giovanni Caggiano & Efrem Castelnuovo & Valentina Colombo & Gabriela Nodari, 2014. "Estimating fiscal multipliers: evidence from a nonlinear world," "Marco Fanno" Working Papers 0179, Dipartimento di Scienze Economiche "Marco Fanno".
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  9. Olivier Blanchard & Roberto Perotti, 2002. "An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output," The Quarterly Journal of Economics, Oxford University Press, vol. 117(4), pages 1329-1368.
  10. James Cloyne, 2013. "Discretionary Tax Changes and the Macroeconomy: New Narrative Evidence from the United Kingdom," American Economic Review, American Economic Association, vol. 103(4), pages 1507-1528, June.
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  12. Timo Teräsvirta & Yukai Yang, 2014. "Linearity and Misspecification Tests for Vector Smooth Transition Regression Models," CREATES Research Papers 2014-04, Department of Economics and Business Economics, Aarhus University.
  13. Morita, Hiroshi, 2015. "State-dependent effects of fiscal policy in Japan: Do rule-of-thumb households increase the effects of fiscal policy?," Journal of Macroeconomics, Elsevier, vol. 43(C), pages 49-61.
  14. Michele Campolieti & Deborah Gefang & Gary Koop, 2014. "Time Variation In The Dynamics Of Worker Flows: Evidence From North America And Europe," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 29(2), pages 265-290, March.
  15. Lo, Ming Chien & Piger, Jeremy, 2005. "Is the Response of Output to Monetary Policy Asymmetric? Evidence from a Regime-Switching Coefficients Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(5), pages 865-886, October.
  16. Jones, Paul M. & Olson, Eric & Wohar, Mark E., 2015. "Asymmetric tax multipliers," Journal of Macroeconomics, Elsevier, vol. 43(C), pages 38-48.
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