What is the best kind of fiscal policy shock?

Hot off the presses from the NBER, from Andrew Mountford and Harald Uhlig, the evidence is mounting:

We propose and apply a new approach for analyzing the effects of fiscal
policy using vector autoregressions. Specifically, we use sign
restrictions to identify a government revenue shock as well as a
government spending shock, while controlling for a generic business
cycle shock and a monetary policy shock. We explicitly allow for the
possibility of announcement effects, i.e., that a current fiscal policy
shock changes fiscal policy variables in the future, but not at
present. We construct the impulse responses to three linear
combinations of these fiscal shocks, corresponding to the three
scenarios of deficit-spending, deficit-financed tax cuts and a balanced
budget spending expansion. We apply the method to US quarterly data
from 1955-2000. We find that deficit-financed tax cuts work best among
these three scenarios to improve GDP
, with a maximal present value
multiplier of five dollars of total additional GDP per each dollar of
the total cut in government revenue five years after the shock.

The emphasis is mine.  I’m not saying you have to believe this paper in all its details (I don’t), but over the next year you will continue to hear talk about the wonders of government spending as fiscal policy.  The science isn’t there.  Here are ungated versions of the paper.


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