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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.

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Recent changes in policy research and in policy-making call for a reassessment of countercyclical fiscal policy. Such a reassesment indicates that countercyclical fiscal policy should focus on the automatic stabilizers rather than discretionary actions. Monetary policy has been reacting more systematically to output and inflation; long expansions in the 1980s and 1990s demonstrate the effectiveness of such a policy. It is unlikely that discretionary countercyclical fiscal policy could improve things, even if there were less uncertainty about fiscal impacts. A discretionary countercyclcal fiscal policy could make monetary policy-making more difficult. Rather discretionary fiscal policy should focus on long run issues, such as tax reform and social security reform.

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.

Abstract This paper studies the effects of discretionary fiscal policy on output volatility and economic growth. Using data on fifty-one countries we isolate three empirical regularities: (1) Governments that use fiscal policy aggressively induce significant macroeconomic instability; (2) The volatility of output caused by discretionary fiscal policy lowers economic growth by 0.6 percentage points for every percentage point increase in volatility; (3) Prudent use of fiscal policy is explained to a large extent by the presence of political constraints and other political and institutional variables. The evidence in the paper supports arguments for constraining discretion by imposing institutional restrictions on governments as a way to reduce output volatility and increase the rate of economic growth.

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In this article we present a simple new Keynesian–style model of debtdriven slumps—that is, situations in which an overhang of debt on the part of some agents, who are forced into rapid deleveraging, is depressing aggregate demand. Making some agents debt-constrained is a surprisingly powerful assumption. Fisherian debt deflation, the possibility of a liquidity trap, the paradox of thrift and toil, a Keynesian-type multiplier, and a rationale for expansionary fiscal policy all emerge naturally from the model. We argue that this approach sheds considerable light both on current economic difficulties and on historical episodes, including Japan’s lost decade (now in its 18th year) and the Great Depression itself. (JEL Codes: E32, E52, E62) I.