What are the Effects of Fiscal Policy Shocks?

We propose and apply a new approach for analyzing the effects of fiscal policy using vector autoregressions. Unlike most of the previous literature this approach does not require that the contemporaneous reaction of some variables to fiscal policy shocks be set to zero or need additional information, such as the timing of wars, in order to identify fiscal policy shocks. The paper's method is a purely vector autoregressive approach which can be universally applied. The approach also has the advantages that it is able to model the effects of announcements of future changes in fiscal policy and that it is able to distinguish between the changes in fiscal variables caused by fiscal policy shocks and those caused by business cycle and monetary policy shocks. We apply the method to US quarterly data from 1955-2000 and obtain interesting results. Our key finding is that the best fiscal policy to stimulate the economy is a deficit-financed tax cut and that the long term costs of fiscal expansion through government spending are probably greater than the short term gains.Fiscal Policy, Vector Autoregression, Bayesian Econometrics, Agnostic identification

Fiscal Policy and Current Account Dynamics in Case of Pakistan

The study empirically investigates the effects of fiscal policy or government budget deficit shocks on the current account and the other macroeconomic variable: real output, real interest rate and exchange rate for Pakistan over the period 1960-2009. The structural Vector Autoregressive model is employed; the exogenous fiscal policy shocks are identified after controlling the business cycle effects on fiscal balances. The results suggest that an expansionary fiscal policy shock improves the current account and depreciates the exchange rate. The rise in private saving and the fall in investment contribute to the current account improvement while the exchange rate depreciation. The twin divergence of fiscal deficit and current account deficit is also explained by the output shock which seems to drive the current account movements and its comovements with the fiscal balance.Restricted Vector Autoregressive model, current account, government budget deficit, fiscal policy, exchange rate

The Effects of Discretionary Fiscal Policy on Macroeconomic Aggregates: A Reappraisal

Fiscal stimuli to recover? A cascade of academic and layman-articles debate the effectiveness of fiscal policy in stimulating the economy backed up by different economic models and empirical support. This essay surveys the theoretical predictions and recent empirical Vector Autoregression (VAR) evidence on the short-run effects of discretionary fiscal policy on macroeconomic aggregates.Macroeconomic Policy, Fiscal Policy, Multipliers, Fiscal Stimulus, VAR

Fiscal Explanations for Inflation: Any Evidence from Transition Economies?

Recent arguments, motivated partly by the new fiscal theory of price level, suggest that fiscal deficits undermine price stability in transition economies. This paper addresses these claims by examining vector-autoregressive models of inflation for three crisis-hidden transition economies (Bulgaria, Romania and Russia). The results indicate that while fiscal deficits have increased inflation in Bulgaria to a certain extent, this has not been the case in Romania and Russia. Even in the Bulgarian case, the usual money aggregate has proven more influential to inflation than fiscal deficits. The analysis based on this method therefore suggests that monetary policy plays an influential role in inflation determination in these countries. In other words, inflationary financing of deficits, rather than deficits themselves, accounts for inflation.fiscal policy; inflation; vector autoregressive models; transition economies

Russian fiscal policy during the financial crisis

This study examines the expanding role of fiscal policy at a time of financial crisis. It analyses the stimulative fiscal measures of the Russian government in 2008-2010 and compares these with simi-lar actions taken in other countries. The risks and limitations associated with the development and implementation of the measures are analyzed. The macroeconomic effects of the fiscal policy measures are estimated using a structural vector autoregressive (SVAR) model, the fiscal multip-liers are calculated, and factors influencing multiplier size are examined.fiscal stimulus; fiscal sustainability; SVAR; fiscal multiplier; financial crisis; Russia

The Economic transmission of fiscal policy shocks from Western to Eastern Europe

This paper studies the transmission of a foreign fiscal policy shock (assumed to be generated in Germany) to key macroeconomic variables in five Central and Eastern European economies (CEE-5). We use quarterly data from 1995 to 2009 and estimate an open economy structural vector autoregressive (SVAR) model identified by imposing reasonable restrictions on contemporaneous responses in the system. Our model is able to identify well-known episodes of fiscal policy action in the countries under review. We find that a foreign fiscal shock affects domestic fiscal variables and vice versa, highlighting the importance of cross-country coordination of fiscal policies within the EU. All the CEE-5 respond to a fiscal expansion abroad with fiscal easing at home (more strongly on the public spending than on the revenue side). We find negative cross-border fiscal spillovers for Slovenia, the Czech Republic and Slovakia, while in Poland and Hungary, output reacts positively to a fiscal expansion in Germany. For domestic fiscal shocks, which we also explore, we find Keynesian responses in Hungary and Slovakia, while non-Keynesian responses are present in the Czech Republic, Poland and Slovenia. Our results imply that “one-size-fits-all” policy recommendations would be too simplistic for the CEE-5; a deeper understanding of the reasons for cross-country differences in response to fiscal shocks is required to be able to provide adequate information to policymakers in these countries.fiscal policy; cross-border spillovers; fiscal multiplier; foreign shock; structural vector autoregression; Central and Eastern Europe; Germany

Measuring the Effects of Fiscal Policy

Measuring the effects of discretionary fiscal policy is both difficult and controversial, as some explicit or implicit identifying assumptions need to be made to isolate exogenous and unanticipated changes in taxes and government spending. Studies based on structural vector autoregressions typically achieve identification by restricting the contemporaneous interaction of fiscal and non-fiscal variables in a rather arbitrary way. In this paper, we relax those restrictions and identify fiscal policy shocks by exploiting the conditional heteroscedasticity of the structural disturbances. We use this methodology to evaluate the macroeconomic effects of fiscal policy shocks in the U.S. before and after 1979. Our results show substantive differences in the economy’s response to government spending and tax shocks across the two periods. Importantly, we find that increases in public spending are, in general, more effective than tax cuts in stimulating economic activity. A key contribution of this study is to provide a formal test of the identifying restrictions commonly used in the literature.Fiscal policy, Government spending, Taxes, Primary deficit, Structural vector auto-regression, Identification

Measuring Fiscal Sustainability for Practical Use in Short-Term Policy Making

This study aims to assess the gross domestic debt sustainability of Turkey through construction of a risk index suitable for short-term policy making. Construction of the risk index follows a methodology similar to the Garcia and Rigobon’s Risk Management Approach (2004). However, unlike most fiscal sustainability studies carried out for Turkey, our index is based on a finite time horizon approach and emphasizes the importance of having a forward-looking measure of fiscal dynamics rather than a test based on past behavior. Within this framework, the main contribution of this paper is to introduce the uncertainty and finite horizon approach into the analysis of the fiscal sustainability of Turkey. A vector-autoregression (VAR) model is used primarily to estimate the joint dynamics of the related macro-variables for the 1990:1-2007:9 periods. Then, the simulated fiscal variables are used to construct the risk index. This index is based on a comparison of a target level of the debt ratio with a simulated debt ratio. Results indicate that the fiscal stance of Turkey has a sustainable outlook through the end of 2007:9.Turkey, Fiscal Sustainability, Monte Carlo Simulation, Vector Auto-Regression

Fiscal shocks and asymmetric effects: a comparative analysis

We empirically test the effects of unanticipated fiscal policy shocks on the growth rate and the cyclical component of real private output and reveal different types of asymmetries in fiscal policy implementation. The data used are quarterly U.S. observati ons over the period 1967:1 to 2011:4. In doing so, we use both a vector autoregressive and the novel support vector machines systems in order to extract the fiscal policy shocks series. The latter has never been used before in a similar macroeconomic setting. Within our research framework, in order to test the robustness of our results to alternative aggregate money supply definitions we use two alternative moentary aggregates. These are the commonly reported by central banks and policy makers simple sum monetary aggregates at the MZM level of aggregation and the alternative CFS Divisia MZM aggregate. From each of these four systems we extracted four types of shocks: a negative and a positive government spending shock and a negative and a positive government revenue shock. These eight different types of unanticipated fiscal policy shocks are next used to empirically examine their effects on the growth rate and the cyclical component of real private GNP in two sets of regressions: one that assumes only contemporaneous effects of the shocks on output and one that is augmented with four lags of each fiscal shock.Comment: 21 Page

Is tighter fiscal policy expansionary under fiscal dominance? Hypercrowding out in Latin America

We test for hypercrowding out as a signal of market concerns over fiscal dominance in five Latin American countries. Hypercrowding out occurs when fiscally dominated governments’ domestic credit demands are perceived as so intrusive to a nation’s financial system that a move towards fiscal surplus lowers interest rates and increases growth. We sample five Latin American countries to test for these relationships. Judged by the results of vector error correction models, three nations test clearly positive, suggesting market concern despite their recent efforts towards fiscal balance.