Working Paper: NBER ID: w13328
Authors: Morten O. Ravn; Stephanie Schmitt-Grohé; Martín Uribe
Abstract: Using panel structural VAR analysis and quarterly data from four industrialized countries, we document that an increase in government purchases leads to an expansion in output and private consumption, a deterioration in the trade balance, and a depreciation of the real exchange rate (i.e., a decrease in the domestic CPI relative to the exchange-rate adjusted foreign CPI). We propose an explanation for these observed effects based on the deep habit mechanism. We estimate the key parameters of the deep-habit model employing a limited information approach. The predictions of the estimated deep-habit model fit well the observed responses of output, consumption, the trade balance, and the real exchange rate to an unanticipated government spending shock. In addition, the deep-habit model predicts that in response to an anticipated increase in government spending consumption and wages fail to increase on impact, which is consistent with the empirical evidence stemming from the narrative identification approach. In this way, the deep-habit model reconciles the findings of the SVAR and narrative literatures on the effects of government spending shocks.
Keywords: government spending shocks; consumption; real exchange rate; SVAR; deep habit model
JEL Codes: E32; E6; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Positive innovation in government spending (H59) | Expansion in output (E23) |
| Positive innovation in government spending (H59) | Expansion in consumption (E20) |
| Positive innovation in government spending (H59) | Deterioration of the trade balance (F14) |
| Positive innovation in government spending (H59) | Depreciation of the real exchange rate (F31) |
| Increase in government purchases (H59) | Increase in output (E23) |
| Anticipated increases in government spending (E62) | Initial decline in consumption (D12) |
| Anticipated increases in government spending (E62) | Initial decline in wages (J39) |
| Unanticipated increases in government spending (E62) | Immediate rise in consumption (D19) |
| Unanticipated increases in government spending (E62) | Immediate rise in wages (J31) |