Fiscal Volatility Shocks and Economic Activity ∗

We study the effects of changes in uncertainty about future fiscal policy on aggregate economic activity. In light of large fiscal deficits and high public debt levels in the U.S., a fiscal consolidation seems inevitable. However, there is notable uncertainty about the policy mix and timing of such a budgetary adjustment. To evaluate the consequences of the increased uncertainty, we first estimate tax and spending processes for the U.S. that allow for timevarying volatility. We then feed these processes into an otherwise standard New Keynesian business cycle model calibrated to the U.S. economy. We find that fiscal volatility shocks can have a sizable adverse effect on economic activity.

[1]  J. Pfeifer,et al.  Policy Risk and the Business Cycle ∗ , 2012 .

[2]  Peter N. Smith,et al.  Durable Consumption, Long-Run Risk and The Equity Premium , 2012 .

[3]  E. Leeper,et al.  Uncertain Fiscal Consolidations , 2012 .

[4]  N. Bloom,et al.  Does Uncertainty Drive Business Cycles? Using Disasters as a Natural Expeiment , 2011 .

[5]  James D. Hamilton,et al.  The Effectiveness of Alternative Monetary Policy Tools in a Zero Lower Bound Environment , 2011 .

[6]  Pablo A. Guerrón-Quintana,et al.  Fortune or Virtue: Time-Variant Volatilities Versus Parameter Drifting , 2010 .

[7]  R. Barro,et al.  Crises and Recoveries in an Empirical Model of Consumption Disasters , 2010 .

[8]  Michael Woodford,et al.  Simple Analytics of the Government Expenditure Multiplier , 2010 .

[9]  Gauti B. Eggertsson.  Federal Reserve Bank of New York Staff Reports What Fiscal Policy Is Effective at Zero Interest Rates ? , 2009 .

[10]  C. Bayer,et al.  Firm-Specific Productivity Risk Over the Business Cycle: Facts and Aggregate Implications , 2009, SSRN Electronic Journal.

[11]  V. Ramey.  Identifying Government Spending Shocks: It's All in the Timing , 2009 .

[12]  E. Leeper,et al.  Dynamics of Fiscal Financing in the United States , 2009 .

[13]  Pablo A. Guerrón-Quintana,et al.  Risk Matters: The Real Effects of Volatility Shocks , 2009 .

[14]  François Gourio.  Disasters and Recoveries , 2008 .

[15]  James D. Hamilton.  Assessing Monetary Policy Effects Using Daily Fed Funds Futures Contracts , 2007 .

[16]  N. Bloom.  The Impact of Uncertainty Shocks , 2007 .

[17]  Francis X. Diebold,et al.  Real-Time Measurement of Business Conditions , 2007 .

[18]  F. Smets,et al.  Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach , 2007 .

[19]  R. Barro.  Rare Disasters and Asset Markets in the Twentieth Century , 2006 .

[20]  Jean Boivin.  Has U.S. Monetary Policy Changed? Evidence from Drifting Coefficients and Real-Time Data , 2006 .

[21]  Giorgio E. Primiceri,et al.  The Time Varying Volatility of Macroeconomic Fluctuations , 2006 .

[22]  Lawrence J. Christiano,et al.  Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy , 2005 .

[23]  Lawrence J. Christiano,et al.  Firm-Specific Capital, Nominal Rigidities and the Business Cycle , 2005 .

[24]  P. Lane,et al.  The Cyclical Behaviour of Fiscal Policy: Evidence from the OECD , 2003 .

[25]  J. Jones.  Has Fiscal Policy Helped Stabilize the Postwar U , 2002 .

[26]  Harald Uhlig,et al.  What are the Effects of Fiscal Policy Shocks? , 2002 .

[27]  Lawrence J. Christiano,et al.  Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy , 2001, Journal of Political Economy.

[28]  J. Galí,et al.  Inflation Dynamics: A Structural Econometric Analysis , 1999 .

[29]  Andrew T. Levin,et al.  Optimal Monetary Policy with Staggered Wage and Price Contracts , 1999, Credit and Capital Markets – Kredit und Kapital: Volume 52, Issue 4.

[30]  H. Bohn,et al.  The Behavior of U. S. Public Debt and Deficits , 1998 .

[31]  M. Shapiro,et al.  Costly Capital Reallocation and the Effects of Government Spending , 1998 .

[32]  A. Gelman,et al.  Weak convergence and optimal scaling of random walk Metropolis algorithms , 1997 .

[33]  L. Tesar,et al.  Effective Tax Rates in Macroeconomics: Cross-Country Estimates of Tax Rates on Factor Incomes and Consumption , 1994 .

[34]  Ellen R. McGrattan,et al.  The macroeconomic effects of distortionary taxation , 1994 .

[35]  R. Braun.  Tax disturbances and real economic activity in the postwar United States , 1994 .

[36]  E. Leeper.  Equilibria under ‘active’ and ‘passive’ monetary and fiscal policies , 1991 .

[37]  R. Barro,et al.  Average Marginal Tax Rates from Social Security and the Individual Income Tax , 1983 .

[38]  Julio J. Rotemberg,et al.  Sticky Prices in the United States , 1982, Journal of Political Economy.

[39]  Richard Hartman,et al.  The effects of price and cost uncertainty on investment , 1972 .

[40]  P. Kehoe,et al.  Financial Markets and Fluctuations in Uncertainty , 2011 .

[41]  R. Barro,et al.  Macroeconomic Effects from Government Purchases and Taxes , 2009 .

[42]  D. Romer,et al.  NBER WORKING PAPER SERIES THE MACROECONOMIC EFFECTS OF TAX CHANGES: ESTIMATES BASED ON A NEW MEASURE OF FISCAL SHOCKS , 2007 .

[43]  Pablo A. Guerrón-Quintana,et al.  Nonlinear Adventures at the Zero Lower Bound , 2012 .

[44]  S. Rehman.  The European Central Bank , 1997 .

[45]  Ricardo J. Caballero.  On the Sign of the Investment-Uncertainty Relationship , 1991 .

[46]  M. Dotsey.  The Economic Effects of Production Taxes in a Stochastic Growth Model , 1990 .

[47]  K. Judd,et al.  Taxation and Uncertainty , 1989 .

[48]  R. Barro,et al.  Measuring the Average Marginal Tax Rate from the Individual Income Tax , 1983 .

[49]  Andrew B. Abel.  Optimal Investment under Uncertainty , 1983 .

[50]  Leonid Hurwicz,et al.  On the Structural Form of Interdependent Systems , 1966 .