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Does anticipation of government spending matter? Evidence from an expectation augmented VAR

  • Tenhofen, Jörn
  • Wolff, Guntram B.

How does private consumption react to an exogenous increase in government expenditure? Standard structural vector autoregressions (SVARs) usually report a positive GDP as well as consumption response, while event studies report a negative consumption response. We investigate in a SVAR whether anticipation of the fiscal shock reverses the sign of this dynamic response to a negative one. As a methodological contribution, we model expectation formation within a SVAR framework. We show for the US that consumption falls in reaction to an expenditure shock once the model allows for one-period-ahead anticipation of this shock. Modelling anticipation of fiscal shocks is thus crucial to correctly capture their macroeconomic effects. Differences in results between event studies and VARs can be explained by missing anticipation in VARs. When re-estimating the two models (with and without anticipation) for non-defense related expenditures, we find a positive consumption response for both models. The implications of our results for macroeconomic theory are briefly discussed.

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Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 1: Economic Studies with number 2007,14.

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Date of creation: 2007
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Handle: RePEc:zbw:bubdp1:5866
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  1. Ellen R. McGrattan & Lee E. Ohanian, 2006. "Does Neoclassical Theory Account for the Effects of Big Fiscal Shocks? Evidence From World War II," NBER Working Papers 12130, National Bureau of Economic Research, Inc.
  2. King, R.G. & Baxter, M., 1990. "Fiscal Policy In General Equilibrium," RCER Working Papers 244, University of Rochester - Center for Economic Research (RCER).
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  8. Giordano, Raffaela & Momigliano, Sandro & Neri, Stefano & Perotti, Roberto, 2007. "The effects of fiscal policy in Italy: Evidence from a VAR model," European Journal of Political Economy, Elsevier, vol. 23(3), pages 707-733, September.
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  10. Chang-Tai Hsieh, 2003. "Do Consumers React to Anticipated Income Changes? Evidence from the Alaska Permanent Fund," American Economic Review, American Economic Association, vol. 93(1), pages 397-405, March.
  11. 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.
  12. Wolff, Guntram B. & Tenhofen, Jörn & Heppke-Falk, Kirsten H., 2006. "The macroeconomic effects of exogenous fiscal policy shocks in Germany: a disaggregated SVAR analysis," Discussion Paper Series 1: Economic Studies 2006,41, Deutsche Bundesbank, Research Centre.
  13. Valerie A. Ramey & Matthew D. Shapiro, 1999. "Costly Capital Reallocation and the Effects of Government Spending," NBER Working Papers 6283, National Bureau of Economic Research, Inc.
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  15. Olivier Biau & Élie Girard, 2005. "Politique budgétaire et dynamique économique en France. L'approche var structurel," Revue économique, Presses de Sciences-Po, vol. 56(3), pages 755-764.
  16. Fatás, Antonio & Mihov, Ilian, 2001. "The Effects of Fiscal Policy on Consumption and Employment: Theory and Evidence," CEPR Discussion Papers 2760, C.E.P.R. Discussion Papers.
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