Fiscal policy and uncertainty

Sam Jerow and Jonathan Wolff

Journal of Economic Dynamics and Control, 2022, vol. 145, issue C

Abstract: We investigate the impact of macroeconomic uncertainty on the stimulative effect of government spending. Using historical macroeconomic time series, we show that government spending multipliers are smaller in episodes characterized by high macroeconomic uncertainty. This state dependence is found to be statistically and economically significant and robust to several alternative specifications. To provide structure, we then build a DSGE model with an agency problem and a forecast-error based uncertainty index. We solve the model via a higher-order perturbation method and use the model to evaluate state-dependent government stimulus. In simulations, we find significant volatility in multipliers as well as co-movements that qualitatively match our empirical results. We find that these results are generated by a reallocation away from risky assets following the government spending shock which triggers a financial accelerator mechanism in our model; we then show that this channel is also active in the data. We conclude that uncertainty plays a significant role in determining the effectiveness of fiscal policy and that business cycle models which abstract from uncertainty can produce misleading policy recommendations.

Keywords: Fiscal policy; Uncertainty; State dependence (search for similar items in EconPapers)
JEL-codes: E30 E60 E62 (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:145:y:2022:i:c:s0165188922002627

DOI: 10.1016/j.jedc.2022.104559

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