Fiscal shocks and their consequences

Craig Burnside, Martin Eichenbaum*, Jonas D.M. Fisher

*Corresponding author for this work

Research output: Contribution to journalArticle

171 Scopus citations

Abstract

This paper investigates the response of hours worked and real wages to fiscal policy shocks in the post-World-War II US. We identify these shocks with exogenous changes in military purchases and argue that they lead to a persistent increase in government purchases and tax rates on capital and labor income, and a persistent rise in aggregate hours worked as well as declines in real wages. The shocks are also associated with short lived rises in aggregate investment and small movements in private consumption. We describe and implement a methodology for assessing whether standard neoclassical models can account for the consequences of a fiscal policy shock. Simple versions of the neoclassical model can account for the qualitative effects of a fiscal shock. Once we allow for habit formation and investment adjustment costs, the model can also account reasonably well for the quantitative effects of a fiscal shock.

Original languageEnglish (US)
Pages (from-to)89-117
Number of pages29
JournalJournal of Economic Theory
Volume115
Issue number1
DOIs
StatePublished - Mar 2004

Keywords

  • Business cycles
  • Fiscal policy
  • Growth model
  • Habit formation
  • Investment adjustment costs

ASJC Scopus subject areas

  • Economics and Econometrics

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