Working Paper: NBER ID: w20179
Authors: Roberto Perotti
Abstract: Impulse responses to government spending shocks in Standard Vector Autoregressions (SVARs) typically display "expansionary" features. However, SVARs can be subject to a "non-fundamentalness" problem. "Expectations - Augmented" VARs (EVARs), which use direct measures of forecasts of defense spending, typically display "contractionary" responses to a defense news shock. I show that, when properly specified, SVARs and EVARs give virtually identical results. The reason for the widespread, opposite view is that defense shocks have "contractionary" effects while civilian government spending shocks have "expansionary" effects. Existing EVARs and SVARs, however, include only total government spending. In addition, the former are typically estimated on samples that include WWII and the Korean war, when defense shocks prevailed, while the latter are estimated mostly on post-1953 samples, when civilian shocks prevailed.
Keywords: government spending; defense spending; civilian spending; economic impact; SVAR; EVAR
JEL Codes: E62; H30; H60
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| defense spending shocks (H56) | contractionary effects arise from distinct nature of shocks (E32) |
| civilian government spending shocks (H56) | expansionary effects arise from distinct nature of shocks (F41) |
| defense spending shocks (H56) | contractionary responses in the economy (E62) |
| defense spending shocks (H56) | decline in private consumption (E20) |
| defense spending shocks (H56) | decline in real wages (F66) |
| civilian government spending shocks (H56) | expansionary effects (F41) |
| civilian government spending shocks (H56) | increase in GDP (E20) |
| civilian government spending shocks (H56) | increase in private consumption (E20) |