Fiscal Foresight and Information Flows
TL;DR: The authors used tax policies as a leading example of foresight, making transparent the economic behavior and information structures that generate non-fundamental equilibria, which pose substantial challenges to econometric efforts to recover the structural shocks to which economic agents react.
Abstract: News�or foresight�about future economic fundamentals can create rational expectations equilibria with non-fundamental representations that pose substantial challenges to econometric efforts to recover the structural shocks to which economic agents react. Using tax policies as a leading example of foresight, simple theory makes transparent the economic behavior and information structures that generate non-fundamental equilibria. Econometric analyses that fail to model foresight will obtain biased estimates of output multipliers for taxes; biases are quantitatively important when two canonical theoretical models are taken as data generating processes. Both the nature of equilibria and the inferences about the effects of anticipated tax changes hinge critically on hypothesized information flows. Different methods for extracting or hypothesizing the information flows are discussed and shown to be alternative techniques for resolving a non-uniqueness problem endemic to moving average representations.
Figures (9)
Figure 3b: Response of K to Technology Increase σ2τ = 1, σ 2 a = 0.01 
Figure 3b: Response of K to Technology Increase σ2τ = 1, σ 2 a = 0.01 
Figure 1. Daily Federal Funds Rate 
Table 2. Benchmark calibration. 
Figure 5. Nondurable Consumption Multipliers: True Value (∗) and Econometrician’s Estimate (+). Anticipated increase in capital taxes using information flows implied by policy rule (25). 
Figure 6. InvestmentMultipliers: True Value (∗) and Econometrician’s Estimate (+). Anticipated increase in capital taxes using information flows implied by policy rule (25). 
Table 3. Business cycle statistics for the model and the U.S. Economy, 1947:1Q-2008:2Q: relative standard deviations are in percent; 1st-order AR is the autoregressive coefficient for each series. 
Table 1. The entries are the multiplication of the zeros inside the unit circle for the structural VAR representation. Smaller numbers indicate a larger discrepancy between the information set of the agent and econometrician, and unity signifies no discrepancy. A * indicates number multiplied by 10−12. 
Figure 4. Output Multipliers: True Value (∗) and Econometrician’s Estimate (+). Anticipated increase in capital taxes using information flows implied by policy rule (25).
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TL;DR: This paper investigated the impact of tax changes on economic activity and found that tax increases are highly contractionary and that the behavior of output following these more exogenous changes indicates that the effects of tax increases were strongly significant, highly robust, and much larger than those obtained using broader measures of tax change.
Abstract: This paper investigates the impact of tax changes on economic activity. We use the narrative record, such as presidential speeches and Congressional reports, to identify the size, timing, and principal motivation for all major post war tax policy actions. This analysis allows us to separate legislated changes into those taken for reasons related to prospective economic conditions and those taken for more exogenous reasons. The behavior of output following these more exogenous changes indicates that tax increases are highly contractionary. The effects are strongly significant, highly robust, and much larger than those obtained using broader measures of tax changes. (JEL E32, E62, H20, N12) Tax changes have been a major public policy issue in recent years. The tax cuts of 2001 and 2003 were passed amid firestorms of debate about their likely effects. Some policymakers claimed that the cuts would both stimulate the economy in the short run and increase normal output in the long run. Others argued that they would raise interest rates and lower confidence and thereby reduce output in both the short run and the long run. That views of the effects of tax changes vary so radically largely reflects the fact that measuring these effects is very difficult. Tax changes occur for many reasons. Some legislated tax changes are passed for philosophical reasons or to reduce an inherited budget deficit. Others are passed because the economy is weak and predicted to fall further, or because a war is in progress and government spending is rising. And many tax changes are not legislated at all, but occur automatically because the tax base varies with the overall level of income, or because of changes in stock prices, inflation, and other nonpolicy forces. Because the factors that give rise to tax changes are often correlated with other developments in the economy, disentangling the effects of the tax changes from the effects of these underlying factors is inherently difficult. There is pervasive omitted variable bias in any regression of output on an aggregate measure of tax changes. This paper suggests one way of dealing with this omitted variable bias. There exists a vast narrative record describing the history and motivation of tax policy changes. We first use this narrative history to separate legislated tax changes from those arising from nonpolicy develop ments. We then use the information on motivation to separate the legislated tax changes into those that are likely to be contaminated by other developments affecting output, and those that can legitimately be used to measure the macroeconomic effects of tax changes. Finally, we use the legitimate observations to derive estimates of the effects of tax changes on output that are likely to be less biased than previous estimates. Section I of the paper elaborates on the conceptual framework for this study. It emphasizes that what we seek to identify from the narrative record are tax changes that are not systematically
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TL;DR: This paper proposed a unified model that generates aggregate and sectoral comovement in response to contemporaneous and news shocks about fundamentals, which is a natural litmus test for macroeconomic models.
Abstract: Aggregate and sectoral comovement are central features of business cycles, so the ability to generate comovement is a natural litmus test for macroeconomic models. But it is a test that most models fail. We propose a unified model that generates aggregate and sectoral comovement in response to contemporaneous and news shocks about fundamentals. The fundamentals that we consider are aggregate and sectoral total factor productivity shocks as well as investment specific technical change. The model has three key elements: variable capital utilization, adjustment costs to investment, and preferences that allow us to parameterize the strength of short-run wealth effects on the labor supply. (JEL
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TL;DR: In this article, the authors distinguish between changes in personal and corporate income taxes and develop a new narrative account of federal tax liability changes in these two tax components, and develop an estimator which uses narratively identified tax changes as proxies for structural tax shocks and apply it to quarterly post-WWII data.
Abstract: This paper estimates the dynamic effects of changes in taxes in the United States. We distinguish between changes in personal and corporate income taxes and develop a new narrative account of federal tax liability changes in these two tax components. We develop an estimator which uses narratively identified tax changes as proxies for structural tax shocks and apply it to quarterly post-WWII data. We find that short run output effects of tax shocks are large and that it is important to distinguish between different types of taxes when considering their impact on the labor market and on expenditure components.
543 citations
References
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01 Jan 2001
TL;DR: In this article, it is shown that the cross spectrum between two variables can be decomposed into two parts, each relating to a single causal arm of a feedback situation, and measures of causal lag and causal strength can then be constructed.
Abstract: There occurs on some occasions a difficulty in deciding the direction of causality between two related variables and also whether or not feedback is occurring. Testable definitions of causality and feedback are proposed and illustrated by use of simple two-variable models. The important problem of apparent instantaneous causality is discussed and it is suggested that the problem often arises due to slowness in recordhag information or because a sufficiently wide class of possible causal variables has not been used. It can be shown that the cross spectrum between two variables can be decomposed into two parts, each relating to a single causal arm of a feedback situation. Measures of causal lag and causal strength can then be constructed. A generalization of this result with the partial cross spectrum is suggested.The object of this paper is to throw light on the relationships between certain classes of econometric models involving feedback and the functions arising in spectral analysis, particularly the cross spectrum and the partial cross spectrum. Causality and feedback are here defined in an explicit and testable fashion. It is shown that in the two-variable case the feedback mechanism can be broken down into two causal relations and that the cross spectrum can be considered as the sum of two cross spectra, each closely connected with one of the causations. The next three sections of the paper briefly introduce those aspects of spectral methods, model building, and causality which are required later. Section IV presents the results for the two-variable case and Section V generalizes these results for three variables.
11,896 citations
"Fiscal Foresight and Information Fl..." refers background in this paper
...Sargent (1981) calls for Granger (1969)-Sims (1972) causality tests to play a key role in helping the econometrician determine which variables properly belong in agents’ information sets....
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TL;DR: In this article, the authors argue that the style in which their builders construct claims for a connection between these models and reality is inappropriate, to the point at which claims for identification in these models cannot be taken seriously.
Abstract: Existing strategies for econometric analysis related to macroeconomics are subject to a number of serious objections, some recently formulated, some old. These objections are summarized in this paper, and it is argued that taken together they make it unlikely that macroeconomic models are in fact over identified, as the existing statistical theory usually assumes. The implications of this conclusion are explored, and an example of econometric work in a non-standard style, taking account of the objections to the standard style, is presented. THE STUDY OF THE BUSINESS cycle, fluctuations in aggregate measures of economic activity and prices over periods from one to ten years or so, constitutes or motivates a large part of what we call macroeconomics. Most economists would agree that there are many macroeconomic variables whose cyclical fluctuations are of interest, and would agree further that fluctuations in these series are interrelated. It would seem to follow almost tautologically that statistical models involving large numbers of macroeconomic variables ought to be the arena within which macroeconomic theories confront reality and thereby each other. Instead, though large-scale statistical macroeconomic models exist and are by some criteria successful, a deep vein of skepticism about the value of these models runs through that part of the economics profession not actively engaged in constructing or using them. It is still rare for empirical research in macroeconomics to be planned and executed within the framework of one of the large models. In this lecture I intend to discuss some aspects of this situation, attempting both to offer some explanations and to suggest some means for improvement. I will argue that the style in which their builders construct claims for a connection between these models and reality-the style in which "identification" is achieved for these models-is inappropriate, to the point at which claims for identification in these models cannot be taken seriously. This is a venerable assertion; and there are some good old reasons for believing it;2 but there are also some reasons which have been more recently put forth. After developing the conclusion that the identification claimed for existing large-scale models is incredible, I will discuss what ought to be done in consequence. The line of argument is: large-scale models do perform useful forecasting and policy-analysis functions despite their incredible identification; the restrictions imposed in the usual style of identification are neither essential to constructing a model which can perform these functions nor innocuous; an alternative style of identification is available and practical. Finally we will look at some empirical work based on an alternative style of macroeconometrics. A six-variable dynamic system is estimated without using 1 Research for this paper was supported by NSF Grant Soc-76-02482. Lars Hansen executed the computations. The paper has benefited from comments by many people, especially Thomas J. Sargent
11,195 citations
Additional excerpts
...and Sims (2002) use a generalized Schur decomposition of Γ0 and Γ1 to show that there exist matrices such that QΛZ ′ = Γ0, Q ΩZ ′ = Γ1, Q Q = Z Z = In×n, where Λ and Ω are upper-triangular....
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TL;DR: In this article, the authors present a model embodying moderate amounts of nominal rigidities that accounts for the observed inertia in inflation and persistence in output, and the key features of their model are those that prevent a sharp rise in marginal costs after an expansionary shock to monetary policy.
Abstract: We present a model embodying moderate amounts of nominal rigidities that accounts for the observed inertia in inflation and persistence in output. The key features of our model are those that prevent a sharp rise in marginal costs after an expansionary shock to monetary policy. Of these features, the most important are staggered wage contracts that have an average duration of three quarters and variable capital utilization.
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