State-dependent effects of fiscal policy

Steven M. Fazzari 1 , James Morley 2  and Irina Panovska 3
  • 1 Department of Economics, Washington University in St. Louis, St. Louis, MO 63130, USA
  • 2 School of Economics, University of New South Wales, Business School, Sydney, NSW 2052, Australia
  • 3 Department of Economics, Lehigh University, 621 Taylor Street, Rauch Business Center, Bethlehem, PA 18015, USA
Steven M. Fazzari, James Morley and Irina Panovska

Abstract

We investigate the effects of government spending on US output with a threshold structural vector autoregressive model. We consider Bayesian model comparison and generalized impulse response analysis to test for nonlinearities in the responses of output to government spending. Our empirical findings support state-dependent effects of fiscal policy, with the government spending multiplier larger and more persistent whenever there is considerable economic slack. Based on capacity utilization as the preferred threshold variable, the estimated multiplier is large (1.6) for a low-utilization regime that accounts for more than half of the sample observations from 1967 to 2012 according to the estimated threshold level.

    • Supplemental_Data_and_Code
  • Anderson, E., A. Inoue, and B. Rossi. 2013. “Heterogeneous Consumers and Fiscal Policy Shocks.” Working Paper.

  • Auerbach, A. J., and Y. Gorodnichenko. 2012a. “Measuring the Output Responses to Fiscal Policy.” American Economic Journal: Economic Policy 4 (2): 1–27.

  • Auerbach, A. J., and Y. Gorodnichenko. 2012b. Fiscal Policy after the Financial Crisis. Eds. Alesina, A. and F. Giavazzi. Chicago: University of Chicago Press.

  • Bachmann, R., and E. R. Sims. 2012. “Confidence and the Transmission of Government Spending Shock.” Journal of Monetary Economics 59: 235–249.

  • Balke, N. 2000. “Credit and Economic Activity: Credit Regimes and Nonlinear Propagation of Shocks.” The Review of Economics and Statistics 82 (2): 344–349.

  • Baum, A., and G. B. Koester. 2011. “The Impact of Fiscal Policy on Economic Activity over the Business Cycle: Evidence from a Threshold VAR.” Deutsche Bundesbank Discussion Paper 03/2011.

  • Baum, A., M. Poplawski-Ribeiro, and A. Weber. 2013. “Fiscal Multipliers and the State of the Economy.” IMF Working Paper WP/12/286.

  • Billi, R. 2011. “Output Gaps and Monetary Policy at Low Interest Rates.” Federal Reserve Bank of Kansas City Economic Review (3): 63–87.

  • Blanchard, O., and R. Perotti. 2002. “An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output.” Quarterly Journal of Economics 117 (4): 329–368.

  • Candelon, B., and L. Lieb. 2013. “Fiscal Policy in Good and Bad Times.” The Journal of Economic Dynamics and Control 37 (12): 2679–2694.

  • Canzoneri, M., F. Collard, H. Dellas, and B. Diba. 2013. “Fiscal Multipliers in Recessions.” Bern University Working Paper 1204.

  • Chib, S., and I. Jeliazkov. 2001. “Marginal Likelihood from the Metropolis-Hastings Output.” Journal of the American Statistical Association 96: 270–281.

  • Christiano, L. M., M. Eichenbaum, and S. Rebelo. 2011. “When Is the Government Spending Multiplier Large?” Journal of Political Economy 119 (1): 78–121.

  • Cogan, J. F., T. Cwik, J. B. Taylor, and V. Wieland. 2010. “New Keynesian Versus Old Keynesian Government Spending Multipliers.” Journal of Economic Dynamics and Control 34: 281–295.

  • Eggertsson, G. B., and P. Krugman. 2012. “Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach.” Quarterly Journal of Economics 26 (3): 1469–1513.

  • Galí, J., D. López-Salido, and J. Vallés. 2007. “Understanding the Effects of Government Spending on Consumption.” Journal of the European Economic Association 5: 227–270.

  • Gerchert, S., and H. Will. 2012. “Fiscal Multipliers: A meta Regression Analysis.” Macreoconomic Policy Institute Working Paper 97.

  • Hamilton, J. 1994. Time Series Analysis. Princeton: Princeton University Press.

  • Hansen, B. E. 1996. “Inference when a Nuisance Parameter is not Identified under the Null Hypothesis.” Econometrica 64: 413–430.

  • Hansen, B. E. 1997. “Inference in TAR Models.” Studies in Nonlinear Dynamics and Econometrics 2 (1): 1–14.

  • Inoue, A., and L. Kilian. 2013. “Inference on Impulse Response Functions in Structural VAR Models.” Journal of Econometrics 31 (1): 78–93.

  • Jorda, O. 2005. “Estimation and Inference of Impulse Responses by Local Projections.” American Economic Review 95 (1): 161–182.

  • Kaplan G., and G. L. Violante. 2011. “A Model of the Consumption Response to Fiscal Stimulus Payments.” NBER Working Paper No. 17338.

  • Kilian, L., and R. J. Vigfusson. 2011. “Are the Responses of the U.S. Economy Asymmetric in Energy Price Increases and Decreases?” Quantitative Economics 2: 419–453.

  • Kim, C-J., and C. R. Nelson. 1999. “Has the US Economy Become More Stable? A Bayesian Approach Based on a Markov-Switching Model of the Business Cycle.” The Review of Economics and Statistics 81 (4): 608–616.

  • Koop, G., M. H. Pesaran, and S. M. Potter. 1996. “Impulse Response Analysis in Nonlinear Multivariate Models.” Journal of Econometrics 74: 119–147.

  • Leigh, D., P. Devries, C. Freedman, J. Guajarado, D. Laxton, and A. Pescatori. 2010. “Will it Hurt? Macroeconomic Effects of Fiscal Consolidation.” IMF World Economic Outlook.

  • Leeper, E. M., N. Traum, and T. B. Walker. 2011. “Clearing up the Fiscal Multiplier Morass.” NBER Working Paper No. 17444.

  • Lo, C. M., and J. Morley. 2013. “Bayesian Analysis of Nonlinear Exchange Rate Dynamics and the Purchasing Power Parity Persistence Puzzle.” UNSW Australian School of Business Research Paper No. 2013-05.

  • Lo, C. M., and J. Piger. 2005. “Is the Response of Output to Monetary Policy Asymmetric? Evidence from a Regime-Switching Coefficients Mode.” Journal of Money, Credit and Banking 37: 865–886.

  • McConnell, M. M., and G. Perez-Quiros. 2000. “Output Fluctuations in the United States: What Has Changed Since the Early 1980s? ” American Economic Review 90 (5): 1464–1676.

  • Mittnik, S., and W. Semmler. 2012. “Regime Dependence of the Fiscal Multiplier.” Journal of Economic Behavior & Organization 83 (3): 502–522.

  • Morley, J., and J. Piger. 2012. The Asymmetric Business Cycle.” The Review of Economics and Statistics 91 (1): 208–221.

  • Morley, J. 2014. “Measuring Economic Slack: A Forecast-Based Approach with Applications to Economies in Asia and the Pacific.” BIS Working Paper No. 451.

  • Orphanides, A., and S. van Norden. 2003. “The Reliability of Inflation Forecasts Based on Output Gap Estimates in Real Time.” Journal of Money, Credit, and Banking 37 (3): 583–601.

  • Owyang, M. T., and S. Zubairy. 2013. “Who Benefits from Increased Government Spending? A State-Level Analysis.” Regional Science and Urban Economics 43 (3): 445–464.

  • Owyang, M. T., V. A. Ramey, and S. Zubairy. 2013. “Are Government Spending Multipliers Greater During Periods of Slack? Evidence from 20th Century Historical Data.” American Economic Review, Papers and Proceedings 103 (3): 129–134.

  • Papell, D. H., C. J. Murray, and H. Ghiblawi. 2000. “The Structure of Unemployment.” Review of Economics and Statistics 82 (2): 309–315.

  • Pappa, E. 2009. “The Effects of Fiscal Shocks on Employment and Real Wages.” International Economic Review 50 (1): 217–244.

  • Parker, J. A. 2011. “On Measuring the Effects of Fiscal Policy in Recessions.” Journal of Economic Literature 49: 703–718.

  • Perotti, R. 2008. “In Search of the Transmission Mechanism of Fiscal Policy.” In NBER Macroeconomic Annual 2007, edited by D. Agemogly, K. Rogoff, and M. Woodford, 169–226. Chicago, Illinois: University of Chicago Press.

  • Ramey, V. A. 2011a. “Can Government Purchases Stimulate the Economy?” Journal of Economic Literature 49 (3): 673–685.

  • Ramey, V. A. 2011b. “Identifying Government Spending Shocks: It’s All in the Timing.” Quarterly Journal of Economics 126 (1): 1–50.

  • Ramey, V. A., and S. Zubairy. 2013. “Government Spending Multipliers in Good Times and in Bad: Evidence from U.S. Historic Data.” Working Paper.

  • Reinhart, C. M., and K. S. Rogoff. 2009. This Time Is Different: Eight Centuries of Financial Folly. Princeton: Princeton University Press.

  • Romer, C., and J. Bernstein. 2009. “The Job Impact of the American Recovery and Reinvestment Plan.” Executive Office of The President of the United States, Council of Economic Advisers Report.

  • Shoag, D. 2013. “The Impact of Government Spending Shocks: Evidence of the Multiplier from State Pension Plan Returns.” Harvard University Working Paper.

  • Sims, C. A. 2001. “Comment on Sargent and Cogley’s ‘Evolving US Postwar Inflation Dynamics.” NBER Macroeconomics Annual 16: 373–379.

  • Tong, H. 1978. On a Threshold Model in Pattern Recognition and Signal Processing. C. H. Chen, Amsterdam: Sighoff and Nordhoff.

  • Tong, H. 1983. Threshold Models in Non-linear Time Series Analysis. New York: Springer-Verlag.

  • Van Brusselen, P. 2009. “Fiscal Stabilization Plans and the Outlook for the World Economy.” NIME Policy Brief 01-2009.

  • Woodford, M. 2011. “Simple Analytics of the Government Expenditure Multiplier.” American Economic Journal: Macroeconomics 3 (1): 1–35.

Purchase article
Get instant unlimited access to the article.
$42.00
Log in
Already have access? Please log in.


Journal + Issues

SNDE recognizes that advances in statistics and dynamical systems theory can increase our understanding of economic and financial markets. The journal seeks both theoretical and applied papers that characterize and motivate nonlinear phenomena. Researchers are required to assist replication of empirical results by providing copies of data and programs online. Algorithms and rapid communications are also published.

Search