Do shocks to government spending raise or lower consumption and real wages? Standard VAR identification approaches show a rise in these variables, whereas the Ramey-Shapiro narrative identification approach finds a fall. I show that a key difference in the approaches is the timing. Both professional forecasts and the narrative approach shocks Granger-cause the VAR shocks, implying that the VAR shocks are missing the timing of the news. Simulations from a standard neoclassical model in which government spending is anticipated by several quarters demonstrate that VARs estimated with faulty timing can produce a rise in consumption even when it decreases in the model. Motivated by the importance of measuring anticipations, I construct two new variables that measure anticipations. The first is based on narrative evidence that is much richer than the Ramey-Shapiro military dates and covers 1939 to 2008. The second is from the Survey of Professional Forecasters, and covers the period 1969 to 2008. All news measures suggest that most components of consumption fall after a positive shock to government spending. The implied government spending multipliers range from 0.6 to 1.1.

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

This essay reviews progress in empirical economics since Leamer’s (1983) critique. Leamer highlighted the benefits of sensitivity analysis, a procedure in which researchers show how their results change with changes in specification or functional form. Sensitivity analysis has had a salutary but not a revolutionary effect on econometric practice. As we see it, the credibility revolution in empirical work can be traced to the rise of a design-based approach that emphasizes the identification of causal effects. Design-based studies typically feature either real or natural experiments and are distinguished by their prima facie credibility and by the attention investigators devote to making the case for a causal interpretation of the findings their designs generate. Design-based studies are most often found in the microeconomic fields of Development, Education, Environment, Labor, Health, and Public Finance, but are still rare in Industrial Organization and Macroeconomics. We explain why IO and Macro would do well to embrace a design-based approach. Finally, we respond to the charge that the design-based revolution has overreached.

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.

government enacted several rounds of activist fiscal policy. These began early in the recession with temporary tax cuts enacted in February 2008, followed by a first-time homebuyers tax credit enacted in July 2008. They reached a crescendo in February 2009 with the American Recovery and Reinvestment Tax Act (ARRA): a combination of tax cuts, transfers to individuals and states, and government purchases estimated to increase budget deficits by a cumulative amount equal to 5.5 percent of one year’s GDP. The fiscal stimulus continued thereafter with more targeted measures, notably the temporary “cash for clunkers ” program in summer 2009 aimed at stimulating the replacement of old cars with new ones, and an extension and expansion of the homebuyers tax credit in November 2009 and July 2010. Accompanying these fiscal efforts were the Troubled Asset Relief Program, enacted in fall 2008 to address the financial crisis, and a continuing array of interventions by the Federal Reserve Board that aimed to stabilize credit markets and stimulate the economy. Around the world, other countries caught in the grip of recession also pursued a variety of active fiscal strategies, ranging from temporary consumption tax rebates (for example, in the

This paper uses a multicountry macroeconometric model to estimate the macroeconomic effects of the U.S. stimulus bill passed in February 2009. The analysis has the advantage of taking into account many endogenous effects. Real U.S. output is estimated to be $554 billion larger when summed over the 12-year period 2009:1–2020:4 (0.29 percent of the total sum of output). The average number of jobs is 509 thousand larger (0.37 percent). There is some redistribution of output and employment away from 2012–2015. At the end of 2020 the federal government debt is larger by $637 billion in real terms (the debt/GDP ratio is larger by 3.19 percentage points), which may increase the risk of negative asset-market reactions. 1

Theory predicts that the effect of fiscal expansion varies with the economic environment, notably the monetary and exchange rate regime, the state of public finances, and the health of the financial system. Using a panel of OECD countries, we evaluate the issue empirically, focusing on the macroeconomic effects of government consumption. Fiscal shocks are identified as residuals from an estimated government spending rule. These shocks are then interacted with conditioning variables in order to explain macroeconomic outcomes across a range of economic environments. The unconditional responses to a spending shock are in line with earlier results, featuring a positive, if relatively small output multiplier, no significant movement in consumption, and a fall in investment and the trade balance. Yet, these average results mask important differences across environments. In particular, the responses of the real exchange rate and net exports vary systematically across exchange rate regimes, with real appreciation and external deficits emerging mainly under a currency peg. Output and consumption multipliers, in turn, become quite sizeable during times of financial crisis. Keywords: JEL-Codes:

This chapter examines the effects of fiscal consolidation —tax hikes and government spending cuts—on economic activity. Based on a historical analysis of fiscal consolidation in advanced economies, and on simulations of the IMF’s Global Integrated Monetary and Fiscal Model (GIMF), it finds that fiscal consolidation typically reduces output and raises unemployment in the short term. At the same time, interest rate cuts, a fall in the value of the currency, and a rise in net exports usually soften the contractionary impact. Consolidation is more painful when it relies primarily on tax hikes; this occurs largely because central banks typically provide less monetary stimulus during such episodes, particularly when they involve indirect tax hikes that raise inflation. Also, fiscal consolidation is more costly when the perceived risk of sovereign default is low. These findings suggest that budget deficit cuts are likely to be more painful if they occur simultaneously across many countries, and if monetary policy is not in a position to offset them. Over the long term, reducing government debt is likely to raise output, as real interest rates decline and the lighter burden of interest payments permits cuts to distortionary taxes. Budget deficits and government debt soared during the Great Recession. In 2009, the budget deficit averaged about 9 percent of GDP in advanced economies, up from only 1 percent of GDP in 2007. 1 By the end of 2010, government debt is expected to reach about 100 percent of GDP—its highest level in 50 years. Looking ahead, population aging could create even more serious problems for public finances. In response to these worrisome developments, virtually all advanced economies will face the challenge of fiscal consolidation. Indeed, many governments are already undertaking or planning The main authors of this chapter are Daniel Leigh (team

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,

This paper was presented at the 50th Economic Policy Panel