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Fiscal Volatility Shocks and Economic Activity

We study the effects of changes in uncertainty about future fiscal policy on aggregate economic activity. First, we estimate tax and spending processes for the U.S. that allow for timevarying volatility. We uncover strong evidence of the importance of this time-varying volatility in accounting for the dynamics of tax and spending data. We then feed these processes into an otherwise standard New Keynesian business cycle model calibrated to the U.S. economy. We find that fiscal volatility shocks can have a sizable adverse effect on economic activity and inflation. An endogenous increase in markups accounts for about half of these.

Jesús Fernández-Villaverde, University of Pennsylvania
Pablo A. Guerron-Quintana, Federal Reserve Bank of Philadelphia
Keith Kuester, University of Bonn
Juan Rubio-Ramirez, Duke University
Publication Date: 
September, 2012
BFI Initiative: 
Publication Status: