When Is Discretionary Fiscal Policy Effective?

66 Pages Posted: 22 Feb 2017 Last revised: 14 Sep 2019

See all articles by Steven M. Fazzari

Steven M. Fazzari

Washington University in St. Louis

James Morley

University of Sydney

Irina Panovska

University of Texas at Dallas

Date Written: September 12, 2019

Abstract

We investigate the effects of discretionary increases and decreases in government spending and taxes using a medium-scale nonlinear vector autoregressive model with policy shocks identified via sign restrictions. Tax cuts and spending increases have larger stimulative effects when there is excess slack in the economy, but they are much less effective, especially in the case of government spending increases, when the economy is close to potential. We find that negative demand shocks have larger effects than positive demand shocks across the business cycle, but this is much more pronounced during periods of slack. Tax increases are contractionary and largely self-defeating in reducing the debt-to-GDP ratio during periods of excess slack. The effectiveness of discretionary government spending, including its state dependence, appears to be due almost entirely to the response of consumption. The responses of both consumption and investment to discretionary tax changes are state dependent, but investment plays the larger quantitative role.

Keywords: Government spending; austerity; nonlinear dynamics; Bayesian; sign restrictions; vector autoregression

JEL Classification: E32; E62; C32

Suggested Citation

Fazzari, Steven M and Morley, James and Panovska, Irina, When Is Discretionary Fiscal Policy Effective? (September 12, 2019). Available at SSRN: https://ssrn.com/abstract=2921667 or http://dx.doi.org/10.2139/ssrn.2921667

Steven M Fazzari

Washington University in St. Louis ( email )

One Brookings Drive
St. Louis, MO 63130
United States
314-935-5693 (Phone)
314-935-4156 (Fax)

James Morley

University of Sydney ( email )

Rm 370 Merewether (H04)
Sydney, NSW 2006 2008
Australia

HOME PAGE: http://https://sites.google.com/site/jamescmorley/

Irina Panovska (Contact Author)

University of Texas at Dallas ( email )

2601 North Floyd Road
Richardson, TX 75083
United States

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