Government Spending Shocks and Private Activity: The Role of Sentiments

Jia, Bijie and Kim, Hyeongwoo (2015): Government Spending Shocks and Private Activity: The Role of Sentiments.

Abstract

This paper studies the dynamic effects of the fiscal policy shock on private activity using an array of vector autoregressive models for the post-war US data. We are particularly interested in the role of consumer sentiment in the transmission of the government spending shock. Our major findings are as follows. Private consumption and investment fail to rise persistently in response to positive spending shocks especially when shocks are anticipated, while they exhibit persistent and significant increases when the sentiment shock occurs. Employment and real wages in the private sector also respond significantly positively only to the sentiment shock. Consumer sentiment responds negatively to a positive fiscal shock, resulting in subsequent decreases in private activity. That is, our empirical findings imply that the government spending shock generates consumer pessimism, which then weakens the effectiveness of the fiscal policy. We further strengthen our claims via counterfactual simulation exercises.

• Item Type: MPRA Paper
• Language: English
• Keywords: Government Spending; Consumer Sentiment; Private Activity; Sentiment Channel; Vector Autoregressive; Expectational VAR; Survey of Professional Forecasters; Threshold VAR; Counterfactual Simulations
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E62 - Fiscal Policy

References

AIYAGARI, S. R., L. J. CHRISTIANO, AND M. EICHENBAUM (1992): "The output, employment, and interest rate effects of government consumption," Journal of Monetary Economics, 30.

AUERBACH, A. J., AND Y. GORODNICHENKO (2012): "Fiscal multipliers in recession and expansion," in Fiscal Policy after the Financial Crisis, NBER Chapters, pp. 63-98. National Bureau of Economic Research, Inc.

BACHMANN, R., AND E. R. SIMS (2012): "Confidence and the transmission of gov- ernment spending shocks," Journal of Monetary Economics, 59, 235-249.

BARRO, R. J., AND C. J. REDLICK (2011): "Macroeconomic effects from government purchases and taxes," The Quarterly Journal of Economics, 126(1), 51-102.

BARSKY, R. B., AND E. R. SIMS (2012): "Information, animal spirits, and the meaning of innovations in consumer confidence," American Economic Review, 102(4), 1343- 77.

BAXTER, M., AND R. G. KING (1993): "Fiscal policy in general equilibrium," American Economic Review, 83(3), 315-34.

BEAUDRY, P., AND F. PORTIER (2004): "When can changes in expectations cause business cycle fluctuations in neo-classical settings?," CEPR Discussion Papers 4628, C.E.P.R. Discussion Papers.

BEAUDRY, P., AND F. PORTIER (2006): "Stock prices, news, and economic fluctuations," American Economic Review, 96(4), 1293-1307.

BLANCHARD, 0. (1993): "Consumption and the recession of 1990-1991," Working pa- pers 93-5, Massachusetts Institute of Technology (MIT), Department of Economics.

BLANCHARD, 0., AND R. PEROTTI (2002): "An empirical characterization of the dynamic effects of changes in government spending and taxes on output," in The Quarterly Journal of Economics, pp. 1329-1368. MIT Press.

BURNSIDE, C., M. EICHENBAUM, AND J. D. M. FISHER (2004): "Fiscal shocks and their consequences," Journal of Economic Theory, 115(1), 89-117.

CAVALLO, E. A. (2005): "Trade, gravity, and sudden stops: On how commercial trade can increase the stability of capital flows," Working Paper 2005-23, Federal Reserve Bank of Atlanta.

CHRISTIANO, L., M. EICHENBAUM, AND 8. REBELO (2009): "When is the government spending multiplier large," NBER Working Paper.

COCHRANE, J. H. (1994): "Shocks," Carnegie-Rochester Conference Series on Public Policy, 41(1), 295-364.

CORSETTI, G., A. MEIER, AND G. J. Mu"LLER (2012): "What determines government spending multipliers?," Economic Policy, 27(72), 521-565.

DEVEREUX, M. B., A. C. HEAD, AND B. J. LAPHAM (1996): "Monopolistic competition, increasing returns, and the effects of government spending," Journal of Money, Credit and Banking, 28(2), 233-54.

EDELBERG, w., M. EICHENBAUM, AND J. D. FISHER (1999): "Understanding the effects of a shock to government purchases," Review of Economic Dynamics, 2(1), 166-206.

FATAS, A., AND I. MIHOV (2001): "The effects of fiscal policy on consumption and employment: Theory and evidence," CEPR Discussion Papers 2760, C.E.P.R. Discussion Papers.

GALI, J., J. D. LOPEZ-8ALIDO, AND J. VALLES (2007): "Understanding the effects of government spending on consumption," Journal of the European Economic Association, 5(1), 227-270.

HALL, R. E. (1986): "The role of consumption in economic fluctuations," in The American Business Cycle: Continuity and Change, NBER Chapters, pp. 237-266. National Bureau of Economic Research, Inc.

HALL, R. E. (1993): "Macro theory and the recession of 1990-1991," American Economic Review, 83(2), 275-79.

HALL, R. E. (2009): "By how much does GDP rise if the government buys more output?," Brookings Papers on Economic Activity, 40(2), 183-249.

ILZETZKI, E., E. G. MENDOZA, AND G. A. VEGH (2013): "How big (small) are fiscal multiplier?," Journal of Monetary Economics, 60, 239-254.

Jia, B., and H. Kim (2016): �Government Spending Shocks and Consumer Sentiment,�unpublised manuscript.

KIM, H., J. KIM, AND M. STERN (2015): "On the robustness of recursively identified VAR models," Working Paper.

KOOP, G., M. H. PESARAN, AND S. M. POTTER (1996): "Impulse response analysis in nonlinear multivariate models," Journal of Econometrics, 74(1), 119-147.

MITTNIK, S., AND W. SEMMLER (2012): "Regime dependence of the fiscal multiplier," Journal of Economic Behavior and Organization, 83, 502-522.

MOUNTFORD, A., AND H. UHLIG (2009): "What are the effects of fiscal policy shocks?," Journal of Applied Econometrics, 24(6), 960-992.

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," NBER Working Papers 18769, National Bureau of Economic Research, Inc.

PEROTTI, R. (2005): "Estimating the effects of fiscal policy in OECD countries," Proceedings.

PEROTTI, R. (2008): "In search of the transmission mechanism of fiscal policy," in NBER Macroeconomics Annual 2007, Volume 22, NBER Chapters, pp. 169-226. National Bureau of Economic Research, Inc.

PEROTTI, R. (2011): "Expectations and fiscal policy: An empirical investigation," Manuscript.

RAMEY, V. A. (2011a): "Can government purchases stimulate the economy?," Journal of Economic Literature, 49:3, 673-685.

RAMEY, V. A. (2011b): "Identification government spending shocks: It's all in the timing," The Quarterly Journal of Economics, 126(1), 1-50.

RAMEY, V. A. (2012): �Government spending and private activity,� in Fiscal Policy after the Financial Crisis. NBER conference.

RAMEY, V. A., AND M. D. SHAPIRO (1998): "Costly capital reallocation and the effects of government spending," Carnegie-Rochester Conference Series on Public Policy, 48(1), 145-194.

RAMEY, V. A., AND S. ZUBAIRY (2014): "Government spending multipliers in good times and in bad: Evidence from U.S. historical data," NBER Working Papers 20719, National Bureau of Economic Research, Inc.

ROTEMBERG, J. J., AND M. WOODFORD (1992): "Oligopolistic pricing and the effects of aggregate demand on economic activity," Journal of Political Economy, 100(6), 1153-1207.