Regime dependence of the fiscal multiplier
01 Aug 2012-Journal of Economic Behavior and Organization (North-Holland)-Vol. 83, Iss: 3, pp 502-522
TL;DR: In this paper, the authors argue that neither conventional VAR analysis nor linearized DGSE models may be appropriate to evaluate demand effects arising from such a stimulus package, and they adopt a regime-dependent VAR approach.
Abstract: After the financial market meltdown of the years 2007–2008 the Obama administration responded with large fiscal stimulus package, yet the reaction to this stimulus has been diverse. Some predicted a multiplier effect in the order of 1.5, others argued that the multiplier will be less than 0.5. Such multiplier estimates typically stem from estimated linear vector autoregressions (VARs) or linearized versions of DSGE models. In this paper, we argue that neither conventional VAR analysis nor linearized DGSE models may be appropriate to evaluate demand effects arising from such a stimulus package. The reason is, as recent research suggests, that the timing of demand shocks matters. To assess the multiplier's variability, we adopt a regime-dependent VAR approach. As is shown in detail, our model specification is grounded on theoretical considerations. The empirical analysis presented here suggests that a regime-dependent VAR-specification is favored for U.S. output and employment data, and that the standard (one-regime) VAR methodology is inappropriate for analyzing multi-regime processes. Although we employ a nonlinear VAR framework, the chosen setup allows the use of largely familiar macroeconometric modeling tools. Estimating a two-regime VAR, we show that the fiscal multiplier varies with the state of the business cycle and the particular specifics of the measure taken. For the U.S. we find, for example, the fiscal expansion multiplier is much higher in a regime of a low economic activity than in a regime of high activity. As we also show it is size dependent.
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TL;DR: The authors investigated whether U.S. government spending multipliers differ according to two potentially important features of the economy: (1) the amount of slack and (2) whether interest rates are near the zero lower bound.
Abstract: This paper investigates whether U.S. government spending multipliers differ according to two potentially important features of the economy: (1) the amount of slack and (2) whether interest rates are near the zero lower bound. We shed light on these questions by analyzing new quarterly historical U.S. data covering multiple large wars and deep recessions. We estimate a state-dependent model in which impulse responses and multipliers depend on the average dynamics of the economy in each state. We find no evidence that multipliers differ by the amount of slack in the economy. These results are robust to many alternative specifications. The results are less clear for the zero lower bound. For the entire sample, there is no evidence of elevated multipliers near the zero lower bound. When World War II is excluded, some point estimates suggest higher multipliers during the zero lower bound state, but they are not statistically different from the normal state. Our results imply that, contrary to recent conjecture, government spending multipliers were not necessarily higher than average during the Great Recession.
657 citations
TL;DR: In this article, the authors estimate nonlinear VARs to assess to what extent fiscal spending multipliers are countercyclical in the United States and deal with the issue of non-fundamentalness due to fiscal foresight by appealing to sums of revisions of expectations of fiscal expenditures.
Abstract: We estimate nonlinear VARs to assess to what extent fiscal spending multipliers are countercyclical in the United States. We deal with the issue of non-fundamentalness due to fiscal foresight by appealing to sums of revisions of expectations of fiscal expenditures. This measure of anticipated fiscal shocks is shown to carry valuable information about future dynamics of public spending. Results based on generalized impulse responses suggest that fiscal spending multipliers in recessions are greater than one, but not statistically larger than those in expansions. However, nonlinearities arise when focusing on “extreme” events, i.e. deep recessions vs. strong expansionary periods.
132 citations
Cites background from "Regime dependence of the fiscal mul..."
...(2012), Mittnik and Semmler (2012), Fazzari et al. (2014).1 Second, anticipation effects are likely to be of great relevance to the transmission of fiscal policy shocks, a phenomenon often referred to as ‘fiscal foresight’ (see, among others, Yang, 2005; Fisher and Peters, 2010; Mertens and Ravn,…...
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TL;DR: In this paper, the effects of government spending on U.S. output with a threshold structural vector autoregressive model were investigated with Bayesian model comparison and generalized impulse response analysis to test for nonlinearities in the responses of output to government spending.
Abstract: We investigate the effects of government spending on U.S. output with a threshold structural vector autoregressive model. We consider Bayesian model comparison and generalized impulse response analysis to test for nonlinearities in the responses of output to government spending. Our empirical findings support state-dependent effects of fiscal policy, with the government spending multiplier larger and more persistent whenever there is considerable economic slack. Based on capacity utilization as the preferred threshold variable, the estimated multiplier is large (1.6) for a low-utilization regime that accounts for more than half of the sample observations from 1967-2012 according to the estimated threshold level.
125 citations
Cites background from "Regime dependence of the fiscal mul..."
...The government spending multiplier could be negative, and if it is positive, it is likely less than unity....
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TL;DR: In this article, the authors employ a multi-regime vector autoregression (MRVAR) approach, which abstains from conventional mean-reversion assumptions and in which adverse asset price movements and their impact on risk premia and credit spreads can induce instabilities in the banking sector.
123 citations
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TL;DR: In this paper, the authors investigate the possibility of a non-linear propagation of fiscal developments according to different financial market stress regimes and show that the responses of economic growth to a fiscal shock are mostly positive in both financial stress regimes.
Abstract: We use a threshold VAR analysis to study whether the effects of fiscal policy on economic activity differ depending on financial market conditions. In particular, we investigate the possibility of a non-linear propagation of fiscal developments according to different financial market stress regimes. More specifically we employ a quarterly dataset, for the U.S., the U.K., Germany and Italy, for the period 1980:4-2009:4, encompassing macro, fiscal and financial variables. The results show that (i) the use of a nonlinear framework with regime switches is corroborated by nonlinearity tests; (ii) the responses of economic growth to a fiscal shock are mostly positive in both financial stress regimes; (iii) financial stress has a negative effect on output growth and worsens the fiscal position; (iv) the nonlinearity in the response of output growth to a fiscal shock is mainly associated with different behaviour across regimes; (v) the size of the fiscal multipliers is higher than average in the last crisis.
116 citations
References
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TL;DR: In this article, the parameters of an autoregression are viewed as the outcome of a discrete-state Markov process, and an algorithm for drawing such probabilistic inference in the form of a nonlinear iterative filter is presented.
Abstract: This paper proposes a very tractable approach to modeling changes in regime. The parameters of an autoregression are viewed as the outcome of a discrete-state Markov process. For example, the mean growth rate of a nonstationary series may be subject to occasional, discrete shifts. The econometrician is presumed not to observe these shifts directly, but instead must draw probabilistic inference about whether and when they may have occurred based on the observed behavior of the series. The paper presents an algorithm for drawing such probabilistic inference in the form of a nonlinear iterative filter
9,189 citations
"Regime dependence of the fiscal mul..." refers methods in this paper
...Two model classes have been proposed for this strategy: (i) Markov switching autoregressions, put forth by Hamilton (1989); and (ii) multi regime (or threshold) autoregressions, proposed by Tong (1978, 1983)....
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TL;DR: In this article, the authors developed a model of staggered prices along the lines of Phelps (1978) and Taylor (1979, 1980), but utilizing an analytically more tractable price-setting technology.
8,580 citations
"Regime dependence of the fiscal mul..." refers background in this paper
...…as expressed in (11) - (13) will allow us to obtain w∗t which depends on the expectation on the technology sequence {At+i}∞i=0.43 Next in the spirit of Calvo (1983) we presume that the existence of adjustment costs entailed by the economy as a whole, a probability ξ, that a fraction of wages will…...
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TL;DR: In this paper, the authors consider the null hypothesis that a time series has a unit root with possibly nonzero drift against the alternative that the process is "trend-stationary" and show how standard tests of the unit root hypothesis against trend stationary alternatives cannot reject the unit-root hypothesis if the true data generating mechanism is that of stationary fluctuations around a trend function which contains a one-time break.
Abstract: We consider the null hypothesis that a time series has a unit root with possibly nonzero drift against the alternative that the process is «trend-stationary». The interest is that we allow under both the null and alternative hypotheses for the presence for a one-time change in the level or in the slope of the trend function. We show how standard tests of the unit root hypothesis against trend stationary alternatives cannot reject the unit root hypothesis if the true data generating mechanism is that of stationary fluctuations around a trend function which contains a one-time break
7,471 citations
TL;DR: In this paper, the authors present a unified approach to impulse response analysis which can be used for both linear and nonlinear multivariate models and demonstrate the use of these measures for a nonlinear bivariate model of US output and the unemployment rate.
3,821 citations
"Regime dependence of the fiscal mul..." refers background in this paper
...Following Koop et al. (1996), so called generalized impulse responses (GIRs), which depend on the overall state, zt, type of shock, vt, and the response horizon, h, are de ned by GIRh(zt, vt) = E (yt+h | zt, ut + vt)− E (yt+h | zt, ut) ....
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TL;DR: Using a Bayesian likelihood approach, the authors estimate a dynamic stochastic general equilibrium model for the US economy using seven macroeconomic time series, incorporating many types of real and nominal frictions and seven types of structural shocks.
Abstract: Using a Bayesian likelihood approach, we estimate a dynamic stochastic general equilibrium model for the US economy using seven macro-economic time series. The model incorporates many types of real and nominal frictions and seven types of structural shocks. We show that this model is able to compete with Bayesian Vector Autoregression models in out-of-sample prediction. We investigate the relative empirical importance of the various frictions. Finally, using the estimated model we address a number of key issues in business cycle analysis: What are the sources of business cycle fluctuations? Can the model explain the cross-correlation between output and inflation? What are the effects of productivity on hours worked? What are the sources of the "Great Moderation"?
3,155 citations
"Regime dependence of the fiscal mul..." refers background in this paper
...Those ones can be found, for example in Smets and Wouters (2007) and Christiano et al. (2009)....
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...15For DSGE models with Keynesian features see Rotemberg andWoodford (1995, 1999), King and Wollman (1999), Gali (1999), Erceg, Henderson and Levin (2000), Woodford (2003), and Smets and Wouters (2007), who present a variety of models with monopolistic competition and sticky prices....
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...The ndings in Cogan et al. (2009), which are based on a model by Smets and Wouters (2007), have received a number of responses in the literature....
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...Moreover, in Smets and Wouters (2007) there is a wedge allowed to be driven between the marginal product of labor and the real wage, so that condition (iii) would not immediately hold....
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...Smets and Wouters (2007), on which the study of Cogan et al. (2009) is based, use 1966:1 2004:4; and Erceg et al. (2008) look at the period 1983:1 2003:4....
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