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Analysis of Fiscal Policy Mutipliers – AMF

Analysis of Fiscal Policy Multipliers

The aim of this project is to analyze the macroeconomic consequences of fiscal policy and to evaluate their effects.

Goals and objectives of the AFPM project

This research projects aims (i) to empirically evaluate the economic consequences of fiscal policy, using state-of-the-art econometric methods, and (ii) to build theoretical models that deliver these effects. This project shed new light on several issues, such as: the optimal composition of a fiscal expansion with respect to tax cuts and spending increases; the appropriate size of an expansionary fiscal policy; delays after which such a plan would affect economic activity…

On the empirical side, our research will offer evaluations of fiscal policy shocks (both anticipated and surprise) using vector autoregressive models. The use of several identification restrictions offers a statistical diagnosis regarding the existence of fiscal shocks. To disentangle fiscal policy shocks from other structural shocks, we will use several testable restrictions such as restrictions on shocks’ persistence. We will deal with pre-announced policy decisions and implementation lags through modifications on the econometrician information set (precisely, through a change in the timing of fiscal variables in the VAR model).

On the theoretical front, this project revisits a fiscal multiplier effect in a walrasian setting. The recent literature mainly modifies the productive side of the economy such that an increase in demand can raise the marginal product of labor. Our own research project studies (short-term) agents’ productive specialization, and therefore differs from the representative agent assumption. This mechanism can substantially modify the qualitative properties of the economy. In particular, it features an effect close to the standard Keynesian spending multiplier.

The results of our work contribute to the reflection on the conduct of economic policy. Indeed, the available estimates of fiscal and fiscal multipliers vary enormously. It is currently difficult to attribute these differences to the choice of methodology, geographical area, type of budget adjustment, etc. The research project helps to better understand different aspects of tax policy. For example, we show that a fiscal stimulus must have a persistent time profile in order to stimulate economic activity (GDP, consumption, investment). Similarly, we have identified various important channels for the transmission of fiscal policy, including the degree of complementarity between public consumption and private consumption. Finally, we have profoundly reconsidered fiscal policy and the Laffer curve in the framework of general equilibrium models in the presence of heterogeneous agents and incomplete markets. It turns out that it is possible to have three levels of income taxes compatible with the same tax revenues.

A better understanding of the effects of these policies is currently crucial for three reasons. First, the cyclical context experienced by the industrialized countries was exceptional in its severity and in fiscal policy measures that were taken. Secondly, we have been able to better understand the transmission mechanisms of tax policies and their consequences for economic activity. Third, economic policy choices vary widely across countries (for example, the time profile of fiscal stimulus policies). This research project sheds light on the consequences of fiscal stimulus by emphasizing the role of agents' expectations. In addition, we have better identified the transmission channels through which these policies propagate within the economy. The empirical results available today differ wildly and the predictions of existing economic theories diverge. Hence, one can neither conclude whether fiscal policy can efficiently stimulate economic activity or not, nor through which channels do such policies propagate through the economy.

Our results were carried out within the academic sphere by the participation of the researchers in seminars and conferences, then by the submission and publication of the works to peer-reviewed journals. The papers have resulted in publications in international peer-reviewed journals: The Review of Economic Studies (top 5 in economics, all fields), The Journal of the European Economic Association (the best European journal in economics), American Economic Journal: Macroeconomics (first review in macroeconomics, in the top 10, all fields combined), European Economic Review (two articles, major general review in Europe), Journal of Applied Econometrics (top field in the field of econometric methods and their application). The project has given rise to other publications in international (2) and national (2) journals.

The goal of this project is to evaluate and to analyze the macroeconomic effects of fiscal policies. For most countries, the last recession has been the toughest one since the great depression. Fiscal policy has played an unprecedented role among stabilization policies, because the 0 lower bound has strongly constrained monetary policy.
Quantifying the effects of fiscal policies is crucial in this context. However, the results of existing empirical studies vary tremendously, and it is currently hard to conclude with any confidence that fiscal policy does stimulate activity (or that it does not).
The research proposal focuses on i) careful empirical evaluation of the effects of fiscal policies, using state-of-the-art econometrics techniques on disaggregated fiscal data, as well as ii) developing frontier theoretic models describing these effects. This research will eventually address questions like the following. What is the proper composition, in terms of tax reductions and increased spending of a successful stimulation plan? What should be the size of such a plan? How long does it take before we observe its first and complete effects on economic activity? How does fiscal policy affect current account, foreign debt and competitivity?
On the empirical side, evaluating the effects of fiscal policy faces a fundamental difficulty: identifying exogenous changes in spending and taxes which cause variations in economic activity, as opposed to endogenous changes in spending and taxes caused by variations in economic activity. This research project aims to deliver a robust and flexible method to estimate the effects of anticipated shocks as well as non-anticipated shocks, and to describe their propagation mechanism.
On the theoretical side, our project is to improve the modeling of exogenous impulses and propagation mechanisms. We will first study the effects of anticipated changes in fiscal policy, as opposed to fiscal policy surprises. Second, we will focus on international effects of fiscal policies, through the current account and the real exchange rate.
Eventually, this project will help inform policymakers and guide them in the design of fiscal stabilization policies.

Project coordinator

Monsieur Patrick FÈVE (Fondation Jean-Jacques laffont / TSE)

The author of this summary is the project coordinator, who is responsible for the content of this summary. The ANR declines any responsibility as for its contents.

Partner

TSE Fondation Jean-Jacques laffont / TSE

Help of the ANR 90,000 euros
Beginning and duration of the scientific project: August 2013 - 48 Months

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