Policymaker Expectations and Fiscal Policy

Martin Ellison and Jason Lennard

No 22127, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: How do policymaker expectations shape fiscal policy? We study this question using British Treasury revenue forecasts, an underexploited source of information on policymakers’ economic outlook. Extracting this information requires separating common macroeconomic expectations from tax-specific variation. We develop a Bayesian dynamic factor model to recover these expectations, drawing on a previously unused Treasury exercise that quantified how individual tax revenues respond to economic activity. The recovered expectations capture pessimism surrounding the return to gold, the deterioration in policymakers’ outlook during the Great Depression, and its improvement as the economy recovered. Tax policy is estimated to have responded systematically to this changing outlook, with deteriorating expectations prompting tax increases and improving expectations prompting tax cuts. These tax changes had sizeable effects on economic activity, with an estimated first-year tax multiplier of -2.1. A counterfactual suggests that the policy response amplified the Great Depression.

Keywords: Policymaker Expectations; Revenue forecasts; Fiscal policy; Bayesian dynamic factor models; Fiscal multipliers (search for similar items in EconPapers)
JEL-codes: C11 C32 E27 E62 E66 N14 (search for similar items in EconPapers)
Date: 2026-11
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