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Assessing the Role of Sentiment in the Propagation of Fiscal Stimulus

Hyeongwoo Kim () and Bijie Jia ()

No auwp2018-08, Auburn Economics Working Paper Series from Department of Economics, Auburn University

Abstract: This paper studies the dynamic effects of the fiscal policy shock on private activity using an array of vector autoregressive models for the post-war U.S. data. We are particularly interested in the role of consumer sentiment in the transmission of fiscal stimulus. Our major findings are as follows. Private spending fails to rise persistently in response to government spending shocks, while they exhibit persistent and significant increases when the sentiment shock occurs. Employing not only linear but also nonlinear state-dependent VAR model estimations, we show that the government spending shock generates consumer pessimism in all phases of business cycle resulting in subsequent decreases in private activity, which ultimately weakens the effectiveness of the fiscal policy. Our counterfactual simulation exercises confirm the important role of sentiment in propagating fiscal stimulus to private spending.

Keywords: Government Spending; Sentiment Channel; Nonlinear VAR; Counterfactual Simulations; Survey of Professional Forecasters (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-mac
Date: 2018-12
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