The Impact of Fiscal Policy on Economic Activity Over the Business Cycle - Evidence from a Threshold VAR Analysis

60 Pages Posted: 8 Jun 2016

See all articles by Anja Baum

Anja Baum

University of Cambridge - Faculty of Economics and Politics

Gerrit Koester

European Central Bank (ECB)

Date Written: 2011

Abstract

Does the state of the business cycle matter for the effects of fiscal policy shocks on GDP? This study analyses quarterly German data from 1976 to 2009 in a threshold SVAR, expanding the SVAR approach by Blanchard and Perotti (2002). In a linear benchmark SVAR, the analysis finds that hiking spending yields a short-term fiscal multiplier of around 0.70, while the fiscal multiplier resulting from an increase in taxes and social security contributions is -0.66. In addition, the threshold model derives fundamentally new insights on the effects of shocks, depending on when in the business cycle they occur, their size and their direction. Most importantly, fiscal spending multipliers are much larger in times of a negative output gap but have only a very limited effect in times of a positive output gap. Discretionary revenue policies, on the other hand, have a generally more limited impact. Our findings have important implications for the optimal fiscal policy mix over different stages of the business cycle. Various robustness checks, including a different threshold specification, do not influence these implications substantially.

Keywords: fiscal policy, business cycle, nonlinear analysis, fiscal multipliers

JEL Classification: E62, E32, C54

Suggested Citation

Baum, Anja and Koester, Gerrit B., The Impact of Fiscal Policy on Economic Activity Over the Business Cycle - Evidence from a Threshold VAR Analysis (2011). Bundesbank Series 1 Discussion Paper No. 2011,03. Available at SSRN: https://ssrn.com/abstract=2785397

Anja Baum (Contact Author)

University of Cambridge - Faculty of Economics and Politics ( email )

Austin Robinson Building
Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom

Gerrit B. Koester

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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