Working Paper: NBER ID: w17317
Authors: Jess Fernández-Villaverde; Pablo A. Guerrón-Quintana; Keith Kuester; Juan 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: Fiscal policy; Economic activity; 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) | reduction in aggregate output (E23) |
| Fiscal volatility shocks (E63) | reduction in consumption (D12) |
| Fiscal volatility shocks (E63) | reduction in investment (G31) |
| Fiscal volatility shocks (E63) | reduction in hours worked (J22) |
| Increase in fiscal policy uncertainty of two standard deviations (E62) | effects similar to a 25-basis-point increase in the federal funds rate (E52) |
| Fiscal volatility shocks (E63) | stagflationary effects (E31) |
| Fiscal volatility shocks (E63) | rise in inflation (E31) |
| Fiscal volatility shocks (E63) | fall in output (E23) |
| Increased uncertainty about future tax rates on capital income (H31) | raising marginal costs for firms (D21) |
| Fiscal volatility shocks (E63) | significant roles during specific historical periods of economic instability (N13) |