For U.S. annual data that include WWII, the estimated multiplier for defense spending is 0.6-0.7 at the median unemployment rate. There is some evidence that this multiplier rises with the extent of economic slack and reaches 1.0 when the unemployment rate is around 12%. Multipliers for non-defense purchases cannot be reliably estimated from U.S. macroeconomic time series because of the lack of good instruments. Since the defense-spending multiplier is typically less than one, greater spending tends to crowd out other components of GDP. The largest effects are on private investment, but non-defense purchases and net exports tend also to fall. The response of private consumer expenditure differs insignificantly from zero. For samples that begin in 1950, increases in average marginal income-tax rates (measured by a newly constructed time series) have a significantly negative effect on real GDP. We lack reliable statistical evidence on how this response divides up between substitution effects from changes in tax rates versus income effects from changes in government revenue. *This research was supported by a grant from the National Science Foundation. We particularly appreciate the assistance with the marginal tax-rate data from Jon Bakija and Dan Feenberg. We

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

We review the evidence on the practice and effects of discretionary fiscal policy, particularly in the context of recent efforts to stimulate the economy, reaching two main conclusions. First, policy interventions have increased in this decade, pre-dating the 2009 stimulus. Second, despite a large economic literature on the topic, the state of theory and evidence is not as "shovel ready" as one would like. Although consumption and investment clearly respond to tax incentives and structural vector autoregressions show that lower taxes and higher government purchases can boost output, it is difficult to apply the findings in the current context, in part because multipliers and policy lags are likely to vary with economic conditions. Dynamic stochastic general equilibrium models can be adapted to address extreme economic conditions, but yield an extremely wide range of predicted impacts. The experience from large downturns – the U.S. Great Depression and the Japanese Lost Decade – is illuminating, but provides little evidence about policy effectiveness because systematic and sustained fiscal interventions were not attempted in either case. This paper was prepared for a conference sponsored by the Federal Reserve Bank of Kansas City

The effect of government spending on income and employment is a central unresolved question in macroeconomics. This paper employs a novel identification strategy to isolate exogenous and unexpected variation in state government spending. State governments manage large defined-benefit pension plans for which they bear the investment risk. Using a newly-collected dataset on the returns and portfolios of these plans, I show that the idiosyncratic component of their returns is a strong predictor of subsequent state government spending. Instrumenting with this ‘windfall ’ component of returns, I find that state government spending has a large positive effect on income and employment. Baseline estimates indicate that each dollar of spending raises in-state income by 2.12, and that 35,000 of spending generates one additional job. These effects are not due to in-state investment bias, are concentrated in the non-traded sector, and are larger during times of labor force ‘slack. ’ Finally, I consider how these results compare with the predictions of a standard macroeconomic model and outline which features in the model are consistent with the empirical findings. ∗I gratefully acknowledge the patient guidance of my adviser Emmanuel Farhi, and my committee members Raj Chetty, Matthew Weinzierl, David Laibson and Robert Barro. I have benefited tremendously from their advice. I also want to thank Erik

In this paper, we estimate government purchase multipliers for a large number of OECD countries, allowing these multipliers to vary smoothly according to the state of the economy and using real-time forecast data to purge policy innovations of their predictable components. We adapt our previous methodology (Auerbach and Gorodnichenko, 2012) to use direct projections rather than the SVAR approach to estimate multipliers, to economize on degrees of freedom and to relax the assumptions on impulse response functions imposed by the SVAR method. Our findings confirm those of our earlier paper. In particular, GDP multipliers of government purchases are larger in recession, and controlling for real-time predictions of government purchases tends to increase the estimated multipliers of government purchases in recession. We also consider the responses of other key macroeconomic variables and find that these responses generally vary over the cycle as well, in a pattern consistent with the varying impact on GDP.

To investigate the time heterogeneity e¤ects of …scal policy in the U.S., we use a non-recursive, Blanchard and Perotti-like structural VAR with time-varying parameters, estimated through Bayesian simulation over the 1965:2–2009:2 period. Our evidence suggests that …scal policy has lost some capacity to stimulate output but that this trend is more pronounced for taxes net of transfers than for government expenditure, whose e¤ectiveness declines only slightly. Fiscal multipliers keep conventional signs throughout. An investigation of changes in …scal policy conduct indicates an increase in the countercyclical activism of net taxes over time, which appears to have reached a maximum during the 2008-09 recession.

California, Berkeley. This paper could not have been written without the generosity of many colleagues who have shared their data with us. We are extremely grateful to Richard Baldwin, Giovanni Federico,

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This paper was presented at the 50th Economic Policy Panel

Proponents of fiscal stimulus argue that government spending is needed to replace the private spending normally lost during a recession. Estimates of the so-called fiscal multiplier based on wartime episodes are used to support the proposition that a peacetime intervention can “stimulate” the economy in a desirable manner. The author argues that a wartime crisis is fundamentally different from a peacetime economic crisis. What may be desirable in war is not necessarily so in peace. This is demonstrated formally in the context of a simple neoclassical model, which delivers fiscal multipliers consistent with the wartime evidence. The optimal fiscal policy, whether it entails expansion or contraction, is independent of the size of the fiscal multiplier. (JEL E6, E62) Federal Reserve Bank of St. Louis Review, March/April 2010, 92(2), pp. 121-27. Should governments attempt to “stimulate ” the economy at the onset of a major recession? Until recently, the conventional wisdom has been that discretionary fiscal policy, even if desirable in principle, is operationally too clumsy a tool to