Working Paper: CEPR ID: DP8528
Authors: Jess Fernández-Villaverde; Pablo A. Guerrón-Quintana; Keith Kuester; Juan Francisco Rubio-Ramírez
Abstract: 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 fiscal 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.
Keywords: DSGE Models; Fiscal Policy; Monetary Policy; Uncertainty
JEL Codes: C11; E10; E30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscal volatility shocks (E63) | Economic activity (E29) |
| Fiscal volatility shocks (E63) | Aggregate output (E23) |
| Fiscal volatility shocks (E63) | Consumption (E21) |
| Fiscal volatility shocks (E63) | Investment (G31) |
| Fiscal volatility shocks (E63) | Hours worked (J22) |
| Increased fiscal policy uncertainty (E62) | Investment (G31) |
| Increased fiscal policy uncertainty (E62) | Future returns on capital (G31) |
| Increase in fiscal policy uncertainty (2 standard deviations) (E62) | Economic effects comparable to 25-basis point innovation in federal funds rate (E43) |
| Heightened fiscal policy uncertainty (E62) | Stagflation (E31) |