Working Paper: NBER ID: w16951
Authors: Eric M. Leeper; Todd B. Walker; Shuchun Susan Yang
Abstract: News--or foresight--about future economic fundamentals can create rational expectations equilibria with non-fundamental representations that pose substantial challenges to econometric efforts to recover the structural shocks to which economic agents react. Using tax policies as a leading example of foresight, simple theory makes transparent the economic behavior and information structures that generate non-fundamental equilibria. Econometric analyses that fail to model foresight will obtain biased estimates of output multipliers for taxes; biases are quantitatively important when two canonical theoretical models are taken as data generating processes. Both the nature of equilibria and the inferences about the effects of anticipated tax changes hinge critically on hypothesized tax information flows. Differential U.S. federal tax treatment of municipal and treasury bonds embeds news about future taxes in bond yield spreads. Including that measure of tax news in identified VARs produces substantially different inferences about the macroeconomic impacts of anticipated taxes.
Keywords: Foresight; Information Flows; Tax Policy; Econometrics
JEL Codes: C5; E62; H30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscal foresight (H68) | biased estimates of output multipliers for taxes (H31) |
| Anticipated tax changes (H26) | economic behavior (D22) |
| Anticipated tax increases (H29) | output (C67) |
| Neglecting foresight (D84) | inference errors (C20) |
| Including measures of tax news (H20) | conclusions regarding macroeconomic impacts of anticipated taxes (H31) |
| Econometrician's information set (D89) | true structural shocks (E32) |