The general equilibrium effects of fiscal policy: estimates for the euro area

Lorenzo Forni (), Libero Monteforte () and Luca Sessa ()
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Luca Sessa: Bank of Italy

No 652, Temi di discussione (Economic working papers) from Bank of Italy, Economic Research Department

Abstract: This paper describes a dynamic stochastic general equilibrium model featuring a fraction of non-Ricardian agents in order to estimate the effects of fiscal policy in the euro area by means of Bayesian techniques. The model accounts for distortionary taxation on labor and capital income and on consumption, while expenditures are broken down into purchases of goods and services, compensation of public employees, and transfers to households. A newly computed quarterly dataset of fiscal variables is used. Our results point to a prevalence of mild Keynesian effects of fiscal policy. In particular, although innovations in fiscal policy variables tend to be rather persistent, government purchases of goods and services and compensation of public employees have small and short-lived expansionary effects on private consumption, while innovations in transfers to households show a slightly more sizeable and lasting effect. On the revenue side, decreases in labor income and consumption tax rates have a sizable effect on consumption and output, while a reduction in capital tax favors investment and output in the medium run. Finally, with the exception of transfers to households and labor income tax rates, most fiscal policy variables contribute little to the cyclical variability of the main macro variables.

Keywords: fiscal policy; distortionary taxation; DSGE modeling; Bayesian estimation (search for similar items in EconPapers)
JEL-codes: E32 E62 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-eec and nep-mac
Date: 2007-11
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