The General Equilibrium Effects of Fiscal Policy: Estimates for the Euro Area

71 Pages Posted: 17 Dec 2007

See all articles by Lorenzo Forni

Lorenzo Forni

International Monetary Fund (IMF)

Libero Monteforte

Bank of Italy

Luca Sessa

Bank of Italy

Date Written: November 2007

Abstract

This paper describes a dynamic stochastic general equilibrium model featuring a fraction of non-Ricardian agents in order to estimate the effects of fiscal policy in the euro area by means of Bayesian techniques. The model accounts for distortionary taxation on labor and capital income and on consumption, while expenditures are broken down into purchases of goods and services, compensation of public employees, and transfers to households. A newly computed quarterly dataset of fiscal variables is used. Our results point to a prevalence of mild Keynesian effects of fiscal policy. In particular, although innovations in fiscal policy variables tend to be rather persistent, government purchases of goods and services and compensation of public employees have small and short-lived expansionary effects on private consumption, while innovations in transfers to households show a slightly more sizeable and lasting effect. On the revenue side, decreases in labor income and consumption tax rates have a sizable effect on consumption and output, while a reduction in capital tax favors investment and output in the medium run. Finally, with the exception of transfers to households and labor income tax rates, most fiscal policy variables contribute little to the cyclical variability of the main macro variables.

Keywords: fiscal policy, distortionary taxation, DSGE modeling, Bayesian estimation

JEL Classification: E32, E62

Suggested Citation

Forni, Lorenzo and Monteforte, Libero and Sessa, Luca, The General Equilibrium Effects of Fiscal Policy: Estimates for the Euro Area (November 2007). Bank of Italy Temi di Discussione Working Paper No. 652. Available at SSRN: https://ssrn.com/abstract=1075266 or http://dx.doi.org/10.2139/ssrn.1075266

Lorenzo Forni (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Libero Monteforte

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Luca Sessa

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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