News and Surprises: Revisiting Fiscal Shocks in the Open Economy

Michail Litainas (), Peter McAdam (), Alberto Montagnoli () and Konstantinos Mouratidis ()
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Michail Litainas: School of Economics, University of Sheffield, Sheffield S1 4DT, UK
Alberto Montagnoli: School of Economics, University of Sheffield, Sheffield S1 4DT, UK
Konstantinos Mouratidis: School of Economics, University of Sheffield, Sheffield S1 4DT, UK

No 2024009, Working Papers from The University of Sheffield, Department of Economics

Abstract: Despite extensive research on fiscal policy effects in recent times, comprehensive studies on the international transmission of structural fiscal shocks remains limited and inconclusive. We address these shortcomings in three key ways. First, we confront the perfect foresight problem associated to anticipated fiscal shocks by incorporating a proxy for fiscal policy news into a detailed multi-country model. This is the first study to use such a proxy to empirically determine the cross-border transmission of US fiscal shocks in such a detailed setting. Second, we use a Bayesian multi-country VAR, which, unlike existing two-country model studies, fully accounts for higher-order spillover effects. Third, with this setup, our empirical results reassess the interpretation of fiscal multipliers from New-Keynesian closed-economy models. Key findings include: i) international spillovers mainly operate through trade channels (expenditure switching and boosting); ii) the transmission mechanism hinges on the recipient country’s underlying ‘growth model; and iii) higher-order spillover effects markedly amplify direct spillover effects; and iv) the exchange rate puzzle is rather an artifact of an omitted variable problem and of the policy regime.

Keywords: Fiscal Foresight; Exchange Rate Puzzle; Openness; Bayesian Multi-Country VAR; Spillovers (search for similar items in EconPapers)
JEL-codes: F15 F32 F41 H62 H68 (search for similar items in EconPapers)
Pages: 46 pages
Date: 2024-11
New Economics Papers: this item is included in nep-opm
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