During World War II and the Korean War, real GDP grew by about half the amount of the increase in government purchases. With allowance for other factors holding back GDP growth during those wars, the multiplier linking government purchases to GDP may be in the range of 0.7 to 1.0, a range generally supported by research based on vector autoregressions that control for other determinants, but higher values are not ruled out. New Keynesian macro models have purchases multipliers in that range as well. On the other hand, neoclassical models have a much lower multiplier, because they predict that consumption falls when purchases rise. The key features of New Keynesian models that deliver a higher multiplier are (1) the decline in the markup ratio of price over cost that occurs in those models when output rises, and (2) the elastic response of employment to an increase in demand. These features alone deliver a fairly high multiplier and they are complementary to another feature associated with Keynes, the linkage of consumption to current income. But without the negative relation between the markup and output, the multiplier is small or negative. The negative relation is consistent with the data under certain assumptions, but is not yet fully supported empirically.

This paper investigates the response of hours worked and real wages to fiscal policy shocks in the U.S. during the post World War II era. We identify these shocks with exogenous changes in military purchases and argue that they lead to a persistent increase in government purchases and tax rates on capital and labor income, and a persistent rise in aggregate hours worked as well as declines in real wages. The shocks are also associated with short lived rises in aggregate investment and small movements in private consumption. We describe and implement a methodology for assessing whether standard neoclassical models can account for the consequences of a fiscal policy shock. Simple versions of the neoclassical model can account for the qualitative effects of a fiscal shock. Once we allow for habit formation and investment adjustment costs, the model can also account reasonably well for the quantitative effects of a fiscal shock. This paper is a substantial revision to “Assessing the Effects of Fiscal Shocks ” which appeared

Abstract: This paper compares the dynamic impact of fiscal policy on macroeconomic variables implied by a large class of general equilibrium models with the empirical results from an identified vector autoregression. In the data we find that positive innovations in government spending are followed by strong and persistent increases in consumption and employment. We compare these findings to several variations of a standard real business cycle model and we find that the positive conditional correlation in the responses of employment and consumption cannot be matched by the model under plausible assumptions for the values of the calibration parameters.

We use rich historical data on military procurement spending across U.S. regions to estimate the effects of government spending in a monetary union. Aggregate military build-ups and drawdowns have differential effects across regions. We use this variation to estimate an “open economy relative multiplier ” of approximately 1.5. We develop a framework for interpreting this estimate and relating it to estimates of the standard closed economy aggregate multiplier. The closed economy aggregate multiplier is highly sensitive to how strongly aggregate monetary and tax policy “leans against the wind. ” In contrast, our open economy relative multiplier “differences out ” these effects because different regions in the union share a common monetary and tax policy. Our estimates provide evidence in favor of models in which demand shocks can have large effects on output.

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A key issue in current research and policy is the size of fiscal multipliers when the economy is in recession. Using a variety of methods and data sources, we provide three insights. First, using regime-switching models, we estimate effects of tax and spending policies that can vary over the business cycle; we find large differences in the size of fiscal multipliers in recessions and expansions with fiscal policy being considerably more effective in recessions than in expansions. Second, we estimate multipliers for more disaggregate spending variables which behave differently in relation to aggregate fiscal policy shocks, with military spending having the largest multiplier. Third, we contrast fiscal multipliers in response to anticipated and unanticipated shocks finding that controlling for anticipated fiscal shocks tends to increase the size of the multipliers.

In this paper, I consider whether postwar fiscal policy has helped stabilize the U.S. economy. I do this by adding to the stochastic growth model fiscal policy feedback rules estimated from postwar data. These rules allow fiscal policies to respond to current and lagged output and labor hours. I use the estimated policy rules to see if postwar fiscal policy reduces output volatility and/or lengthens expansions and shortens recessions. I find that fiscal policy in general provides little stability on either count. I also find that the endogenous feedback links, by themselves, can provide some stabilization.

This paper explores a new approach to identifying government spending shocks which avoids many of the shortcomings of existing approaches. The new approach is to identify government spending shocks with statistical in-novations to the accumulated excess returns of large US military contractors. This strategy is used to estimate the dynamic responses of output, hours, con-sumption and real wages to a government spending shock. We find that positive government spending shocks are associated with increases in output, hours, and consumption. Real wages initially decline after a government spending shock and then rise after a year. We estimate the government spending multiplier associated with increases in military spending to be about 1.5 over a horizon of 5 years.

Programme, Contract number 225342. Financial assistance was also received from the

grateful to my discussants, Martin Feldstein and Fumio Hayashi, other conference participants, and Darrel Cohen for comments on an earlier draft, to Kristy Piccinini for research assistance, On March 9, 2002, President Bush signed the Job Creation and Worker Assistance Act. The Act included a temporary increase in depreciation allowances for business spending on equipment and software, in the form of 30 percent partial expensing, and a temporary extension of unemployment benefits. At the time, the motivation of the Act was that it would provide