Government Spending Reloaded: Informational Insufficiency and Heterogeneity in Fiscal VARs

Ellahie, Atif and Ricco, Giovanni (2012): Government Spending Reloaded: Informational Insufficiency and Heterogeneity in Fiscal VARs.

Abstract

Using a large information Bayesian VAR, we approximate the flow of information received by economic agents to investigate the effects of government spending. We document robust evidence that insufficiency of information in conventional models could explain inconsistent results across samples and identifications (Recursive Structural VAR and Expectational VAR). Furthermore, we report heterogeneous effects of government spending components. While aggregate government spending does not appear to produce a strong stimulative effect with output multiplier around 0.7, government investment components have multipliers well above unity. Also, state and local consumption, which captures investment in education and health, elicits a strong response.

• Item Type: MPRA Paper
• Language: English
• Keywords: fiscal shocks, government spending, fiscal foresight, Survey of Professional Forecasters, Structural VARs, Expectational VARs, Large Bayesian VARs.
• Subjects: C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C32 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes ; State Space Models; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E62 - Fiscal Policy; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles

References

Alesina, Alberto, Carlo Favero, and Francesco Giavazzi (2012) “The Output Effect of Fiscal Consolidations,” NBER Working Papers 18336, National Bureau of Economic Research, Inc.

Alessi, Lucia, Matteo Barigozzi, and Marco Capasso (2011) “Non-Fundamentalness in Structural Econometric Models: A Review,” International Statistical Review, Vol. 79, No. 1, pp. 16–47, 04.

Aschauer, David Alan (1989) “Is public expenditure productive?” Journal of Monetary Economics, Vol. 23, No. 2, pp. 177–200, March.

Auerbach, Alan and Yuriy Gorodnichenko (2012) “Fiscal Multipliers in Recession and Expansion,” in Fiscal Policy after the Financial Crisis: National Bureau of Economic Research, Inc.

Bai, Jushan and Serena Ng (2002) “Determining the Number of Factors in Approximate Factor Models,” Econometrica, Vol. 70, No. 1, pp. 191–221, January.

Banbura, Marta, Domenico Giannone, and Lucrezia Reichlin (2010) “Large Bayesian vector auto regressions,” Journal of Applied Econometrics, Vol. 25, No. 1, pp. 71–92.

Baxter, Marianne and Robert G King (1993) “Fiscal Policy in General Equilibrium,” American Economic Review, Vol. 83, No. 3, pp. 315–34, June.

B´en´etrix, Agustin S. (2012) “Fiscal Shocks And Real Wages,” International Journal of Finance & Economics, Vol. 17, No. 3, pp. 203–220, 07.

Bernanke, Ben S., Jean Boivin, and Piotr Eliasz (2004) “Measuring the Effects of Monetary Policy: A Factor-Augmented Vector Autoregressive (FAVAR) Approach,” NBER Working Papers 10220, National Bureau of Economic Research, Inc.

Blanchard, Olivier and Daniel Leigh (2013) “Growth Forecast Errors and Fiscal Multipliers,” IMF Working Papers 13/1, International Monetary Fund.

Blanchard, Olivier and Roberto Perotti (2002) “An Empirical Characterization Of The Dynamic Effects Of Changes In Government Spending And Taxes On Output,” The Quarterly Journal of Economics, Vol. 117, No. 4, pp. 1329–1368, November.

Bouakez, Hafedh, Michel Normandin, and Denis Larocque (2013) “Separating the Wheat from the Chaff: A Disaggregate Analysis of the Effects of Public Spending in the U.S.,”Technical report, Annual T2M Conference Paper.

Christiano, Lawrence J, Martin Eichenbaum, and Charles Evans (1996) “The Effects of Monetary Policy Shocks: Evidence from the Flow of Funds,” The Review of Economics and Statistics, Vol. 78, No. 1, pp. 16–34, February.

Christiano, Lawrence, Martin Eichenbaum, and Sergio Rebelo (2011) “When Is the Government Spending Multiplier Large?” Journal of Political Economy, Vol. 119, No. 1, pp. 78 – 121.

Corsetti, Giancarlo, Keith Kuester, and Gernot M¨uller (2011) “Floats, pegs and the transmission of fiscal policy,” CEPR Discussion Papers 8180, C.E.P.R. Discussion Papers.

De Mol, Christine, Domenico Giannone, and Lucrezia Reichlin (2008) “Forecasting using a large number of predictors: Is Bayesian shrinkage a valid alternative to principal components?” Journal of Econometrics, Vol. 146, No. 2, pp. 318–328, October.

Doan, Thomas, Robert B. Litterman, and Christopher A. Sims (1983) “Forecasting and Conditional Projection Using Realistic Prior Distributions,” NBER Working Papers 1202, National Bureau of Economic Research, Inc.

Favero, Carlo and Francesco Giavazzi (2007) “Debt and the Effects of Fiscal Policy,” NBER Working Papers 12822, National Bureau of Economic Research, Inc. Fernald, John G. (1999) “Roads to Prosperity? Assessing the Link between Public Capital and Productivity,” American Economic Review, Vol. 89, No. 3, pp. 619–638, June.

Fisher, Jonas D.M. and Ryan Peters (2010) “Using Stock Returns to Identify Government Spending Shocks,” Economic Journal, Vol. 120, No. 544, pp. 414–436, 05.

Forni, Mario and Luca Gambetti (2010) “Fiscal Foresight and the Effects of Goverment Spending,” CEPR Discussion Papers 7840, C.E.P.R. Discussion Papers

Forni, Mario and Luca Gambetti (2011) “Sufficient information in structural VARs,” Center for Economic Research (RECent) 062, University of Modena and Reggio E., Dept. of Economics.

Forni, Mario, Domenico Giannone, Marco Lippi, and Lucrezia Reichlin (2009) “Opening The Black Box: Structural Factor Models With Large Cross Sections,” Econometric Theory, Vol. 25, No. 05, pp. 1319–1347, October.

Forni, Mario, Marc Hallin, Marco Lippi, and Lucrezia Reichlin (2000) “The Generalized Dynamic-Factor Model: Identification And Estimation,” The Review of Economics and Statistics, Vol. 82, No. 4, pp. 540–554, November.

Gal´ı, Jordi, J. David L´opez-Salido, and Javier Vall´es (2007) “Understanding the Effects of Government Spending on Consumption,” Journal of the European Economic Association, Vol. 5, No. 1, pp. 227–270, 03.

Giannone, Domenico and Lucrezia Reichlin (2006) “Does information help recovering structural shocks from past observations?” Journal of the European Economic Association, Vol. 4, No. 2-3, pp. 455–465, 04-05.

Giannone, Domenico, Michele Lenza, and Giorgio E. Primiceri (2012) “Prior Selection for Vector Autoregressions,” Working Papers ECARES 2012-002, ULB – Universite Libre de Bruxelles.

Hall, Robert E. (2009) “By How Much Does GDP Rise If the Government Buys More Output?” Brookings Papers on Economic Activity, Vol. 40, No. 2 (Fall), pp. 183–249.

Hansen, Lars Peter and Thomas J. Sargent (1980) “Formulating and estimating dynamic linear rational expectations models,” Journal of Economic Dynamics and Control, Vol. 2, No. 1, pp. 7–46, May.

Ilzetzki, Ethan, Enrique G. Mendoza, and Carlos A. V´egh (2010) “How Big (Small?) are Fiscal Multipliers?” CEP Discussion Papers dp1016, Centre for Economic Performance, LSE.

Koop, Gary (2011) “Forecasting with Medium and Large Bayesian VARs,” Working Papers 1117, University of Strathclyde Business School, Department of Economics.

Leeper, Eric M., Todd B. Walker, and Shu-Chun S. Yang (2010) “Government investment and fiscal stimulus,” Journal of Monetary Economics, Vol. 57, No. 8, pp. 1000–1012, November.

Leeper, Eric M., Todd B. Walker, and Shu-Chun Susan Yang (2013) “Fiscal Foresight and Information Flows,” Econometrica, Vol. 81, No. 3, pp. 1115–1145, 05.

Lippi, Marco and Lucrezia Reichlin (1993) “The Dynamic Effects of Aggregate Demand and Supply Disturbances: Comment,” American Economic Review, Vol. 83, No. 3, pp. 644–52, June.

Lippi, Marco and Lucrezia Reichlin (1994) “VAR analysis, nonfundamental representations, blaschke matrices,” Journal of Econometrics, Vol. 63, No. 1, pp. 307–325, July.

Litterman, Robert B. (1979) “Techniques of forecasting using vector autoregressions,” Technical report.

Mertens, Karel and Morten O. Ravn (2010) “Measuring the Impact of Fiscal Policy in the Face of Anticipation: A Structural VAR Approach,” Economic Journal, Vol. 120, No. 544, pp. 393–413, 05.

Mertens, Karel and Morten O. Ravn (2013) “The Dynamic Effects of Personal and Corporate Income Tax Changes in the United States,” American Economic Review, Vol. 103, No. 4, pp. 1212–47, June.

Monacelli, Tommaso and Roberto Perotti (2008) “Fiscal Policy, Wealth Effects and Markups,” cepr discussion papers, C.E.P.R. Discussion Papers.

Mountford, Andrew and Harald Uhlig (2009) “What are the effects of fiscal policy shocks?” Journal of Applied Econometrics, Vol. 24, No. 6, pp. 960–992.

Onatski, Alexei (2009) “Testing Hypotheses About the Number of Factors in Large Factor Models,” Econometrica, Vol. 77, No. 5, pp. 1447–1479, 09.

Pappa, Evi (2009) “The Effects Of Fiscal Shocks On Employment And The Real Wage,” International Economic Review, Vol. 50, No. 1, pp. 217–244, 02.

Parker, Jonathan A. (2011) “On Measuring the Effects of Fiscal Policy in Recessions,” Journal of Economic Literature, Vol. 49, No. 3, pp. 703–18, September.

Perotti, Roberto (2005) “Estimating the effects of fiscal policy in OECD countries,” Proceedings.

Perotti, Roberto (2008) “In Search of the Transmission Mechanism of Fiscal Policy,” in NBER Macroeconomics Annual 2007, Volume 22: National Bureau of Economic Research, Inc, pp. 169–226.

Perotti, Roberto (2011) “Expectations and Fiscal Policy: An Empirical Investigation,”Technical report.

Ramey, Valerie A. (2011a) “Identifying Government Spending Shocks: It’s all in the Timing,” The Quarterly Journal of Economics, Vol. 126, No. 1, pp. 1–50.

Ramey, Valerie A. (2011b) “Can Government Purchases Stimulate the Economy?” Journal of Economic Literature, Vol. 49, No. 3, pp. 673–85, September.

Ricco, Giovanni (2013) “A New Identification of Fiscal Shocks based on the Information Flow,” working paper, London Business School.

Sims, Christopher A (1980) “Macroeconomics and Reality,” Econometrica, Vol. 48, No. 1, pp. 1–48, January.

Sims, Christopher A. (1992) “Interpreting the macroeconomic time series facts: The effects of monetary policy,” European Economic Review, Vol. 36, No. 5, pp. 975–1000, June.

Woodford, Michael (2011) “Simple Analytics of the Government Expenditure Multiplier,” American Economic Journal: Macroeconomics, Vol. 3, No. 1, pp. 1–35, January.