A central question in the empirical fiscal policy literature is the magnitude, in fact even
the sign, of the fiscal multiplier. Standard identification schemes for fiscal VAR models
typically imply positive output as well as labor productivity responses to expansionary
government spending shocks. The standard macro assumption of decreasing returns to
labor, however, implies that expansionary government spending shocks should lead to
increasing output and hours, but to decreasing labor productivity. To potentially reconcile
theory and empirical analysis we impose, amongst other sign restrictions, opposite signs
of the impulse responses of output and labor productivity to government spending shocks
in eight- to ten-variable VAR models, estimated on quarterly US data. Doing so leads to
contractionary effects of positive government spending shocks. This potentially surprising
finding is robust to the inclusion of variable capital utilization rates and total factor
productivity
