Estimating the Effects of Fiscal Policy in OECD Countries

Abstract

This paper studies the effects of fiscal policy on GDP, inflation and interest rates in 5 OECD countries, using a structural Vector Autoregression approach. Its main results can be summarized as follows: 1) The effects of fiscal policy on GDP tend to be small: government spending multipliers larger than 1 can be estimated only in the US in the pre-1980 period. 2) There is no evidence that tax cuts work faster or more effectively than spending increases. 3) The effects of government spending shocks and tax cuts on GDP and its components have become substantially weaker over time; in the post-1980 period these effects are mostly negative, particularly on private investment. 4) Only in the post-1980 period is there evidence of positive effects of government spending on long interest rates. In fact, when the real interest rate is held constant in the impulse responses, much of the decline in the response of GDP in the post-1980 period in the US and UK disappears. 5) Under plausible values of its price elasticity, government spending typically has small effects on inflation. 6) Both the decline in the variance of the fiscal shocks and the change in their transmission mechanism contribute to the decline in the variance of GDP after 1980.