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When is discretionary fiscal policy effective?

Steven Fazzari, James Morley and Irina Panovska

Studies in Nonlinear Dynamics & Econometrics, 2021, vol. 25, issue 4, 229-254

Abstract: We investigate the effects of discretionary changes in government spending and taxes using a medium-scale nonlinear vector autoregressive model with policy shocks identified via sign restrictions. Tax cuts and spending increases have larger stimulative effects when there is excess slack in the economy, while they are much less effective, especially in the case of government spending increases, when the economy is close to potential. We find that contractionary shocks have larger effects than expansionary shocks across the business cycle, but this is much more pronounced during deep recessions and sluggish recoveries than in robust expansions. Notably, tax increases are highly contractionary and largely self-defeating in reducing the debt-to-GDP ratio when the economy is in a deep recession. The effectiveness of discretionary government spending, including its state dependence, appears to be almost entirely due to the response of consumption. The responses of both consumption and investment to discretionary tax changes are state dependent, but investment plays the larger quantitative role.

Keywords: austerity; Bayesian; government spending; nonlinear dynamics; sign restrictions; vector autoregression (search for similar items in EconPapers)
JEL-codes: C32 E32 E62 (search for similar items in EconPapers)
Date: 2021
References: Add references at CitEc
Citations: View citations in EconPapers (3)

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DOI: 10.1515/snde-2018-0113

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