Fiscal Developments and Financial Stress: A Threshold VAR Analysis

62 Pages Posted: 11 Apr 2011

See all articles by António Afonso

António Afonso

University of Lisbon - ISEG (School of Economics and Management); UECE (Research Unit on Complexity and Economics); ISEG Lisbon School of Economics and Management,Universidade de Lisboa

Jaromir Baxa

Charles University in Prague - Institute of Economic Studies; Institute of Information Theory and Automation, Prague

Michal Slavik

European Central Bank (ECB) - Directorate General Economics

Date Written: March 17, 2011

Abstract

We use a threshold VAR analysis to study whether the effects of fiscal policy on economic activity differ depending on financial market conditions. In particular, we investigate the possibility of a non-linear propagation of fiscal developments according to different financial market stress regimes. More specifically we employ a quarterly dataset, for the U.S., the U.K., Germany and Italy, for the period 1980:4-2009:4, encompassing macro, fiscal and financial variables. The results show that (i) the use of a nonlinear framework with regime switches is corroborated by nonlinearity tests; (ii) the responses of economic growth to a fiscal shock are mostly positive in both financial stress regimes; (iii) financial stress has a negative effect on output growth and worsens the fiscal position; (iv) the nonlinearity in the response of output growth to a fiscal shock is mainly associated with different behaviour across regimes; (v) the size of the fiscal multipliers is higher than average in the last crisis.

Keywords: fiscal policy, financial markets, threshold VAR

JEL Classification: E62, G15, H60

Suggested Citation

Afonso, António and Baxa, Jaromir and Slavik, Michal, Fiscal Developments and Financial Stress: A Threshold VAR Analysis (March 17, 2011). ECB Working Paper No. 1319, Available at SSRN: https://ssrn.com/abstract=1789065

António Afonso (Contact Author)

University of Lisbon - ISEG (School of Economics and Management) ( email )

R. Miguel Lupi, 20
Lisbon, 1248-078
Portugal
+351 21 392 5985 (Phone)
+351 21 396 6407 (Fax)

HOME PAGE: http://https://www.iseg.ulisboa.pt/aquila/homepage/aafonso

UECE (Research Unit on Complexity and Economics)

Rua Miguel Lupi 20
Lisbon, 1249-078
Portugal
+351-213 925 912 (Phone)
+351-213 971 196 (Fax)

HOME PAGE: http://https://uece.rc.iseg.ulisboa.pt/

ISEG Lisbon School of Economics and Management,Universidade de Lisboa ( email )

Rua do Quelhas 6
LISBOA, 1200-781
Portugal

Jaromir Baxa

Charles University in Prague - Institute of Economic Studies ( email )

Opletalova 26
Praha 1, 11000
Czech Republic

Institute of Information Theory and Automation, Prague ( email )

Pod vodarenskou vezi 4
Praha, CZ-18208
Czech Republic

Michal Slavik

European Central Bank (ECB) - Directorate General Economics ( email )

Kaiserstrasse 29
D-60311 Frankfurt am Main
Germany

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