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Reconciling VAR-based and Narrative Measures of the Tax-Multiplier

Carlo Favero () and Francesco Giavazzi ()

No 361, Working Papers from IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University

Abstract: The currently available empirical evidence shows remarkable differences between various estimates of the effects on U.S output of an exogenous shift in Federal tax liabilities. Shocks identified via the narrative method, imply a multiplier of about three over . an horizon of three years. Tax shocks identified in fiscal VAR models deliver a much smaller multipier of about one. Is this heterogeneity real, or is it simply the result of different approaches to the identification of exogenous shifts in taxes? Or of different specifications of the empirical model used to estimate the tax multiplier? In this paper we reconcile this apparently contradictory evidence by showing that the large multiplier obtained via the narrative identification methods are generated by the choice of a limited information approach in their estimation and not by the different nature of the shocks. Using the shocks identified by a Narrative methods in a multivariate dynamic model delivers estimates of the tax multiplier very much in line with those obtained in the traditional fiscal VAR approach.

Date: 2010
New Economics Papers: this item is included in nep-cba, nep-mac and nep-pub
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