Working Paper: NBER ID: w14551
Authors: Andrew Mountford; Harald Uhlig
Abstract: We propose and apply a new approach for analyzing the effects of fiscal policy using vector autoregressions. Specifically, we use sign restrictions to identify a government revenue shock as well as a government spending shock, while controlling for a generic business cycle shock and a monetary policy shock. We explicitly allow for the possibility of announcement effects, i.e., that a current fiscal policy shock changes fiscal policy variables in the future, but not at present. We construct the impulse responses to three linear combinations of these fiscal shocks, corresponding to the three scenarios of deficit-spending, deficit-financed tax cuts and a balanced budget spending expansion. We apply the method to US quarterly data from 1955-2000. We find that deficit-financed tax cuts work best among these three scenarios to improve GDP, with a maximal present value multiplier of five dollars of total additional GDP per each dollar of the total cut in government revenue five years after the shock.
Keywords: Fiscal Policy; Vector Autoregressions; Government Spending; Tax Cuts
JEL Codes: C32; E60; E62; H20; H50; H60
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| deficit-financed tax cuts (H62) | GDP growth (O49) |
| deficit spending (H62) | economic stimulation (O51) |
| deficit spending (H62) | private investment (E22) |
| deficit spending (H62) | interest rates (E43) |
| deficit spending (H62) | real wages (J31) |
| government spending shocks (E62) | consumption (E21) |
| government spending shocks (E62) | real wages (J31) |