The Effects of Fiscal Policy on Output: A DSGE Analysis

By: Davide Furceri and Annabelle Mourougane

http://d.repec.org/n?u=RePEc:oec:ecoaaa:770-en&r=dge

This paper examines the effects of fiscal policy on output in the euro area. For this purpose we develop a DSGE Fiscal Model with endogenous government bond yields to assess the impact of different fiscal policy shocks on output, its components and on government debt. The simulations suggest that fiscal policy is effective in supporting activity, especially in the short term. In particular, the largest fiscal multipliers are found for an increase in public investment, public consumption and a cut in the wage tax. The results are robust to different parameter calibrations and are economically significant. Amongst the different structural parameters, the share of liquidity constrained households and price persistence are found to be the ones which affect the most fiscal multipliers.

DSGE models do not find large multipliers from government expenses because the Ricardian Equivalence holds, or almost holds. In this paper, liquidity constraints allow for strong deviations from Ricardian Equivalence, and thus more substantial multipliers.

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One Response to The Effects of Fiscal Policy on Output: A DSGE Analysis

  1. Agent Continuum says:

    The model is neither estimated nor simulated (there’s no table of second and cross moments to compare with the filtered data moments, as customary), so this must be a proof-of-concept model that’s supposed to show us what’s possible, in particular that fiscal policy can be effective (breakdown of Ricardian Equivalence) and that different instruments have different results in terms of magnitude. The problem is that we knew this, from even simpler models.

    The paper is sold also based on the claim that it’s making endogenous the link between the stock of debt and the interest rate the government needs to pay to service debt (as opposed to the short-run rate that the Central Bank pegs). But in the paper this is not obtained from some equilibrium conditions but rather assumed (equation 29/page 11). D’oh.

    The monetary authority passively follows a rule and fiscal policy is equally inert (linear decision rules and a residual tax to rule out explosive paths). A loss function or some other basic model of fiscal decision-making would have been better, in my humble opinion.

    Yet another paper with “Monetary policy” but no money stock, no role for money and no consolidated government budget constraint (where’s the seigniorage?). Thank you, our New Keynesian Overlords!

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