Chronicle of a War Foretold: The Macroeconomic Effects of Anticipated Defense Spending Shocks

Evi Pappa and Nadav Ben Zeev

No 9948, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We identify US defense news shocks as shocks that best explain future movements in defense spending over a five-year horizon and are orthogonal to current defense spending. Our identified shocks are strongly correlated with the Ramey (2011) news shocks, but explain a larger share of macroeconomic fluctuations and have significant demand effects. Fiscal news induces significant and persistent increases in output, consumption, investment, hours and the interest rate. Standard DSGE models fail to produce such a pattern. We propose a sticky price model with distortionary taxation, variable capital utilization, capital adjustment costs and rule-of-thumb consumers that replicates the empirical findings.

Keywords: Defense spending news; Dsge model; Maximum forecast error variance; Svar (search for similar items in EconPapers)
JEL-codes: E62 E65 H30 (search for similar items in EconPapers)
Date: 2014-04
New Economics Papers: this item is included in nep-dge and nep-mac
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Citations: View citations in EconPapers (28)

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Journal Article: Chronicle of a War Foretold: The Macroeconomic Effects of Anticipated Defence Spending Shocks (2017)
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