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Abstract: There seems to be a widespread belief among economists, policy-makers, and members of the media that the "confidence'" of households and businesses is a critical component in the transmission of fiscal policy shocks into economic activity. We take this proposition to the data using standard structural VARs with government spending and aggregate output augmented to include empirical measures of consumer or business confidence. We also estimate non-linear VAR specifications to allow for differential impacts of government spending in "normal'' times versus recessions. In normal times confidence does not react significantly to unexpected increases in government spending and spending multipliers are in the neighborhood of one; during recessions confidence rises and spending multipliers are significantly larger. We then quantify the importance of the systematic response of confidence to spending shocks for the spending multiplier and find that, in normal times, confidence is irrelevant for the transmission of government spending shocks to output, but during periods of economic slack it is important. We argue and present evidence that it is not confidence per se â?? in the sense of pure sentiment â?? that matters for the transmission of spending shocks during downturns, but rather that the composition of spending during a downtown is different. In particular, spending shocks during downturns predict future productivity improvements through a persistent increase in government investment relative to consumption, which is in turn reflected in higher measured confidence.
We empirically revisit the crowding-in effect of government spending on private consumption based on rolling windows of U.S. data. Results show that in earlier samples government spending is increasingly crowding in private consumption; however, this relation is reverted in the latest periods. We propose a model embedding non-separable public and private consumption in the utility function and rule-of-thumb consumers to assess the sources of non-monotonic changes in the transmission of the shock. The iterative full information estimation of the model reveals that changes in the co-movement between private and public spending is primarily driven by the fluctuations in the elasticity of substitution between private and public consumption, the share of financially constrained consumers, and the elasticity of intertemporal substitution.
This paper investigates the international transmission of fiscal shocks between two closely-linked, open economies. We estimate impulse response functions using a semi-structural vector auto regressive (VAR) model and quarterly data from Australia and New Zealand for the period 1973:3-2008:4. We compare our empirical results with impulse response functions from a calibrated two-country international real business cycle model with habit formation and adjustment costs to investment. We show that a positive shock to Australian government consumption leads to an increase in Australian output initially and then to a decline in the medium term, while the New Zealand output is negatively affected both in the short and medium term. This result is in line with the recent literature that reports beggar-thy-neighbour effect of positive government spending shocks.
The recent recession has brought fiscal policy back to the forefront, with economists and policy makers struggling to reach a consensus on highly political issues like tax rates and government spending. At the heart of the debate are fiscal multipliers, whose size and sensitivity determine the power of such policies to influence economic growth. Fiscal Policy after the Financial Crisis focuses on the effects of fiscal stimuli and increased government spending, with contributions that consider the measurement of the multiplier effect and its size. In the face of uncertainty over the sustainability of recent economic policies, further contributions to this volume discuss the merits of alternate means of debt reduction through decreased government spending or increased taxes. A final section examines how the short-term political forces driving fiscal policy might be balanced with aspects of the long-term planning governing monetary policy. A direct intervention in timely debates, Fiscal Policy after the Financial Crisis offers invaluable insights about various responses to the recent financial crisis.
This paper discusses the effect of government spending shocks on economic performance in the European debt crisis with a particular focus on spending based consolidation. It examines the question whether the following economic environment conditions alter the fiscal transmission mechanism of government spending shocks: fixed exchange rate, fiscal strain, financial crisis and the zero lower bound of nominal interest. These are relevant for countries affected by the crisis. While there is extensive research on government spending shocks and also on differences in their effects across economic environments, there is no specific application of this kind of research to the cumulative conditions as found in the European sovereign debt crisis. Therefore, the effects of spending shocks are estimated in a baseline scenario of an unconstrained open economy and subsequently compared with an extended model controlling for the relevant environment variables. The empirical cross-country analysis of 30 OECD countries over the last three decades aims to estimate the effects in a two-stage regression model, which first identifies a series of fiscal shocks and subsequently estimates the pooled effect of those shocks on key macroeconomic variables. It is found that positive government spending shocks exert a negative but not significant effect on economic performance and the demand channel, both in the baseline model and when applying constraints relevant to the sovereign debt crisis.
Using structural VAR analysis, we document that in a panel of industrialized countries, an increase in government purchases leads to an expansion in output and private consumption, a deterioration in the trade balance, and a depreciation of the real exchange rate (i.e., a decrease in the domestic CPI relative to the exchange-rate adjusted foreign CPI). We propose an explanation for these observed effects based on the deep habit mechanism. We estimate the key parameters of the deep-habit model employing a limited information approach. The predictions of the estimated deep-habit model fit remarkably well the observed responses of output, consumption, the trade balance, and the real exchange rate to an unanticipated government spending shock. In addition, the deep-habit model predicts that in response to an anticipated increase in government spending consumption and wages fail to increase on impact, which is consistent with the empirical evidence stemming from the narrative identification approach. In this way, the deep-habit model reconciles the findings of the SVAR and narrative literatures on the effects of government spending shocks.
Do shocks to government spending raise or lower consumption and real wages? Standard VAR identification approaches show a rise in these variables, whereas the Ramey-Shapiro narrative identification approach finds a fall. I show that a key difference in the approaches is the timing. Both professional forecasts and the narrative approach shocks Granger-cause the VAR shocks, implying that the VAR shocks are missing the timing of the news. Simulations from a standard neoclassical model in which government spending is anticipated by several quarters demonstrate that VARs estimated with faulty timing can produce a rise in consumption even when it decreases in the model. Motivated by the importance of measuring anticipations, I construct two new variables that measure anticipations. The first is based on narrative evidence that is much richer than the Ramey-Shapiro military dates and covers 1939 to 2008. The second is from the Survey of Professional Forecasters, and covers the period 1969 to 2008. All news measures suggest that most components of consumption fall after a positive shock to government spending. The implied government spending multipliers range from 0.6 to 1.1.