What are the effects of fiscal policy shocks

A.W. Mountford, H.F.H.V.S. Uhlig

Research output: Contribution to journalArticleScientificpeer-review

416 Citations (Scopus)

Abstract

We propose and apply a new approach for analyzing the effects of fiscal policy using vector autoregressions. Specifically, we use sign restrictions to identify a government revenue shock as well as a government spending shock, while controlling for a generic business cycle shock and a monetary policy shock. We explicitly allow for the possibility of announcement effects, i.e., that a current fiscal policy shock changes fiscal policy variables in the future, but not at present. We construct the impulse responses to three linear combinations of these fiscal shocks, corresponding to the three scenarios of deficit-spending, deficit-financed tax cuts and a balanced budget spending expansion. We apply the method to US quarterly data from 1955-2000. We find that deficit-financed tax cuts work best among these three scenarios to improve GDP, with a maximal present value multiplier of five dollars of total additional GDP per each dollar of the total cut in government revenue five years after the shock.
Original languageEnglish
Pages (from-to)960-992
JournalJournal of Applied Econometrics
Volume24
Issue number6
Publication statusPublished - 2009

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    Mountford, A. W., & Uhlig, H. F. H. V. S. (2009). What are the effects of fiscal policy shocks. Journal of Applied Econometrics, 24(6), 960-992.