Increases in government spending trigger substitution effects—both inter- and intra-temporal—and a wealth effect. The ultimate impacts on the economy hinge on current and expected monetary and fiscal ...policy behavior. Studies that impose active monetary policy and passive fiscal policy typically find that government consumption crowds out private consumption: higher future taxes create a strong negative wealth effect, while the active monetary response increases the real interest rate. This paper estimates Markov-switching policy rules for the United States and finds that monetary and fiscal policies fluctuate between active and passive behavior. When the estimated joint policy process is imposed on a conventional new Keynesian model, government spending generates positive consumption multipliers in some policy regimes and in simulated data in which all policy regimes are realized. The paper reports the model's predictions of the macroeconomic impacts of the American Recovery and Reinvestment Act's implied path for government spending under alternative monetary–fiscal policy combinations.
Clearing Up the Fiscal Multiplier Morass Leeper, Eric M.; Traum, Nora; Walker, Todd B.
The American economic review,
08/2017, Volume:
107, Issue:
8
Journal Article
Peer reviewed
Open access
We quantify government spending multipliers in US data using Bayesian prior and posterior analysis of a monetary model with fiscal details and two distinct monetary-fiscal policy regimes. The ...combination of model specification, observable data, and relatively diffuse priors for some parameters lands posterior estimates in regions of the parameter space that yield fresh perspectives on the transmission mechanisms that underlie government spending multipliers. Short-run output multipliers are comparable across regimes—posterior means around 1.3 on impact—but much larger after 10 years under passive money/active fiscal than under active money/passive fiscal—90 percent credible sets of 1.5, 1.9 versus 0.1, 0.4 in present value, when estimated from 1955 to 2016.
General equilibrium models that include policy rules for government spending, lump-sum transfers, and distortionary taxation on labor and capital income and on consumption expenditures are fit to US ...data under rich specifications of fiscal policy rules to obtain several results. First, the best-fitting model allows many fiscal instruments to respond to debt. Second, responses of aggregates to fiscal policy shocks under rich rules vary considerably from responses where only non-distortionary fiscal instruments finance debt. Third, in the short run, all fiscal instruments except labor taxes react strongly to debt, but long-run intertemporal financing comes from all components of the government’s budget constraint. Fourth, debt-financed fiscal shocks trigger long-lasting dynamics; short-run and long-run multipliers can differ markedly.
Generalizing the Taylor Principle Davig, Troy; Leeper, Eric M.
The American economic review,
06/2007, Volume:
97, Issue:
3
Journal Article
Peer reviewed
Open access
The paper generalizes the Taylor principle-the proposition that central banks can stabilize the macroeconomy by raising their interest rate instrument more than one-for-one in response to higher ...inflation-to an environment in which reaction coefficients in the monetary policy rule change regime, evolving according to a Markov process. We derive a long-run Taylor principle which delivers unique bounded equilibria in two standard models. Policy can satisfy the Taylor principle in the long run, even while deviating from it substantially for brief periods or modestly for prolonged periods. Macroeconomic volatility can be higher in periods when the Taylor principle is not satisfied, not because of indeterminacy, but because monetary policy amplifies the impacts offundamental shocks. Regime change alters the qualitative and quantitative predictions of a conventional new Keynesian model, yielding fresh interpretations of existing empirical work.
•The inflation bias problem is greater in the presence of short-term government debt.•Time-consistent policy deviates from tax smoothing to reduce the inflation bias.•Policy response to shocks is ...driven by desire to reduce the inflation bias, and hence is hugely different under discretion relative to commitment.•Equilibrium debt rises with debt maturity and policy myopia but falls in markups.•Endogenizing debt maturity controls the speed of fiscal correction.
The textbook optimal policy response to an increase in government debt is simple—monetary policy should actively target inflation, and fiscal policy should smooth taxes while ensuring debt sustainability. Such policy prescriptions presuppose an ability to commit. Without that ability, the temptation to use inflation surprises to offset monopoly and tax distortions, as well as to reduce the real value of government debt, creates a state-dependent inflationary bias problem. High debt levels and short-term debt exacerbate the inflation bias. But this produces a debt stabilization bias because the policy maker wishes to deviate from the tax smoothing policies typically pursued under commitment, by returning government debt to steady-state. As a result, the response to shocks in New Keynesian models can be radically different, particularly when government debt levels are high and maturity short.
FISCAL FORESIGHT AND INFORMATION FLOWS Leeper, Eric M.; Walker, Todd B.; Yang, Shu-Chun Susan
Econometrica,
20/May , Volume:
81, Issue:
3
Journal Article
Peer reviewed
Open access
News—or foresight—about future economic fundamentals can create rational expectations equilibria with non-fundamental representations that pose substantial challenges to econometric efforts to ...recover the structural shocks to which economic agents react. Using tax policies as a leading example of foresight, simple theory makes transparent the economic behavior and information structures that generate non-fundamental equilibria. Econometric analyses that fail to model foresight will obtain biased estimates of output multipliers for taxes; biases are quantitatively important when two canonical theoretical models are taken as data generating processes. Both the nature of equilibria and the inferences about the effects of anticipated tax changes hinge critically on hypothesized information flows. Different methods for extracting or hypothesizing the information flows are discussed and shown to be alternative techniques for resolving a non-uniqueness problem endemic to moving average representations.
Government investment and fiscal stimulus Leeper, Eric M.; Walker, Todd B.; Yang, Shu-Chun S.
Journal of monetary economics,
11/2010, Volume:
57, Issue:
8
Journal Article
Peer reviewed
Open access
Effects of government investment are studied in an estimated neoclassical growth model. The analysis focuses on two dimensions that are critical for understanding government investment as a fiscal ...stimulus: implementation delays for building public capital and expected fiscal adjustments to deficit-financed spending. Implementation delays can produce small or even negative labor and output responses to increases in government investment in the short run. Anticipated fiscal adjustments matter both quantitatively and qualitatively for long-run growth effects. When public capital is insufficiently productive, distorting financing can make government investment contractionary at longer horizons.
► Implementation delays associated with government infrastructure spending can hinder the beneficial effects of that spending in the short run. ► Expected fiscal financing of government infrastructure spending can hinder the beneficial effects of that spending in the long run. ► Implementation delays associated with government infrastructure spending can reduce private investment more and raise labor and output less (or even lower them) in the short run, compared to the case without delays. ► Distorting fiscal financing of government investment dampens the growth effects of that investment in the long run.
Surplus–debt regressions Leeper, Eric M.; Li, Bing
Economics letters,
02/2017, Volume:
151
Journal Article
Peer reviewed
Open access
Single-equation estimates of fiscal reaction functions, which relate primary surpluses to past debt–GDP ratios and control variables, are subject to potentially serious simultaneity bias that can ...produce misleading inferences about fiscal behavior. Biases arise from failure to model the general equilibrium relationships between government debt and surpluses, relationships that bring in the forward-looking nature of nominal debt valuation and the role of monetary policy in that valuation.
•Surplus–debt regressions are potentially subject to simultaneity bias.•Bias stems from ignoring general equilibrium relationship between debt and surplus.•The nature of the bias depends on the underlying monetary–fiscal policy regime.•Bias can be serious enough to produce misleading inferences about fiscal behavior.•Good estimate of fiscal behavior calls for estimation in general equilibrium setup.
Uncertain Fiscal Consolidations Bi, Huixin; Leeper, Eric M.; Leith, Campbell
The Economic journal (London),
February 2013, Volume:
123, Issue:
566
Journal Article
Peer reviewed
Open access
This article explores the macroeconomic consequences of fiscal consolidations whose timing and composition — either tax—or spending— based — are uncertain. We find that the composition of the fiscal ...consolidation, its duration, the monetary policy stance, the level of government debt, and expectations over the likelihood and composition of fiscal consolidations all matter in determining the extent to which a given consolidation is expansionary or successful in stabilising government debt. We argue that the conditions that could render fiscal consolidation efforts expansionary are unlikely to apply in the current economic environment.
Modest policy interventions Leeper, Eric M.; Zha, Tao
Journal of monetary economics,
11/2003, Volume:
50, Issue:
8
Journal Article
Peer reviewed
Open access
We present a theoretical and empirical framework for computing and evaluating linear projections conditional on hypothetical paths of monetary policy. A
modest policy intervention does not ...significantly shift agents’ beliefs about policy regime and does not induce the changes in behavior that Lucas (Carnegie–Rochester Conference Series on Public Policy, Vol. 1, Amsterdam, North-Holland, 1976, pp. 104–130) emphasizes. Applied to an econometric model of U.S. monetary policy, we find that a rich class of interventions routinely considered by the Federal Reserve is modest and their impacts can be reliably forecasted by an identified linear model. Modest interventions can shift projected paths and probability distributions of macro variables in economically meaningful ways.
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