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1 Introduction
The effectiveness of fiscal policy to stimulate activity remains a highly controversial topic, as it resurfaced in
the discussion of the stimulus packages implemented in the wake of the 20082009 recession. This controversy stems in the first place from the differences between the predictions of neoclassical and Keynesian and
some New Keynesian macromodels. Empirical investigation could be expected to shed light on the debate,
but the measurement of fiscal policy impacts is fraught with problems of endogeneity and anticipation. Different ways to overcome them lead to different estimated shock series and measured effects.
Yet another problem in this context is that, even within the same approach, results may vary substantially when the sample period varies. Subsample instability has been mentioned, but not much explored in
the original SVAR contribution in the field by Blanchard and Perotti (2002). Subsequent work in this vein
[e.g., Perotti (2004) and Pereira (2009)] paid more attention to the issue. However, in these and in other
studies, inference appears somewhat fragile because the number and timing of the breaks has been imposed
from the outset. Usually, only one abrupt change is allowed and its dating is made to coincide with the emergence of the Great Moderation or with changes in the conduct of monetary policy.
In the event study approach for the identification of spending shocks, time heterogeneity issues were
also initially overlooked. However, recent work belonging to this strand of the literature (Ramey 2011) has
introduced improved measures of military spending shocks and presented some results on (in)stability
of the findings. Ramey reports subsample results for one of the new shock measures proposed and, for
instance, finds clearly different impacts of fiscal policy when the sample starts in 1955 vis--vis when it
includes WWII.
The issue of time-variation must be given careful consideration if one is to determine precisely what the
existing identification methodologies imply in terms of fiscal policy impacts. This paper takes up this issue in
the framework of the Blanchard and Perotti identification approach, by embedding it into a VAR with timevarying parameters (TVP). As argued forcefully in Primiceri (2005) and Boivin (2006), these models have
great flexibility in terms of capturing non-linearities and time heterogeneity, and are free from the shortcomings of less formal alternatives, such as split- or rolling-sample estimates. On the one hand, they allow one
to adopt an agnostic position concerning the number, the timing and the shape of the breaks. On the other
hand, they permit to associate the uncovered time-variation with some measure of its precision.
M.C. Pereira and A.S. Lopes: Time-varying fiscal policy in the US159
xt=Xtt+ut,(1)
Atut=Btet,(2)
et=Dtt,(3)
1 b12
0 a13 a14
0
1 a23 0
0 1
At =
,
B
=
t
0 0
0 a 32
1
0
0 0
0 0
.
1 0
0 1
(4)
We identify shocks to net taxes and expenditure, and impose a convenient orthogonalization between
price and output shocks ordering the latter variable in the second place. Net taxes respond contemporaneously to prices and output, but expenditure responds only to the first of these variables. This latter restriction
is common in fiscal VARs identified by restrictions on the matrices of contemporaneous coefficients. Output
0
At =
0
1 a
0 1
0
23
1 12 13
a14
1 0
0
0
,
B
=
t
0 32 1
0
1
41 42 43
0
,
0
(4)
which form an identification scheme equivalent to (4), in the sense that it yields the same impulse-responses
in a time-invariant setting.2 As shown in Appendix C, there is a one-to-one correspondence between the
parameters of both schemes; in particular, the calibrated parameters coincide. Hence, Bayesian estimation
take as a reference the definition of matrices At and Bt as given in (4).
When studying the effects of fiscal policy on private consumption, we consider a generalization of the
baseline system including the latter variable. This is ordered last in the system, and a convenient orthogonalization in relation to output and prices is imposed. This should be innocuous for the object of interest: the
effects of fiscal policy shocks. It is straightforward to modify the identification methodology for the baseline
specification to accommodate such an extension.
M.C. Pereira and A.S. Lopes: Time-varying fiscal policy in the US161
t = t1 + et ,
(5)
bi , t = bi , t1 + etbi , i = 1, 3, 4,
log dt = log dt1 + etd ,
(6)
(7)
where it is assumed that et ~ i.i.d.N (0, Q ), etbi ~ i.i.d.N (0, Q i ), and etd ~ i.i.d.N (0, Q d ), and that disturbances
b
et , eib, t , and etd are orthogonal to each other and also to t. The elements of matrices Q, Q i and Qd are
usually called the hyperparameters. Apart from block-diagonality of covariance of the innovations relating to
covariance states, we impose no other restrictions on the matrices of hyperparameters.
The simulation of the heteroskedastic TVP-VAR using Bayesian methods is by now fairly standard, so we
outline here the main steps and give full details in Appendix B. The algorithm iterates on a number of blocks
using the conditioning feature of the Gibbs sampler. The time-varying parameters are treated as unobserved
state variables whose dynamics are governed by the transition equations (5), (6) or (7). These, together with
the measurement equations relating the state variables to the data, form a normal linear state-space model
in each block. A Bayesian algorithm for this model, as proposed in Carter and Kohn (1994) [see also Kim and
Nelson (1999b) for a description], is run sequentially, sampling the state vectors from the posterior Gaussian
distributions with mean and covariance matrix obtained from running the ordinary Kalman filter followed
by a backward recursion.
More precisely, the Gibbs simulation algorithm consists of going through the following steps at each
iteration.
Step 1 The measurement equation in this block is given by (1) and the state equation by (5). A history of s is
generated conditional on the data, histories of covariance and volatility states (which yield a history of s)
and the covariance of innovations in the state equation (Q).
Step 2 The normal linear state space algorithm is applied sequentially, equation by equation, conditional on
the data, histories of coefficient and volatility states, and the covariance of innovations in state equations
b
( Q i ). The measurement equations come from (4) and the state equations from (6). A history of b3s is generated firstly; then, conditional on it, a history of b1s and, finally, conditional on both, a history of b4s.
Step 3 The measurement equation is based on a transformed version of (3) and the state equation is (7). A
history of log ds is generated conditional on the data, histories of coefficient and covariance states, and the
covariance of innovations in state equation (Qd).
Step 4 The models hyperparameters, Q, Q bi and Qd, are generated conditional on histories of the corresponding state vectors (s, bis and log ds).
There is one further aspect that merits discussion in our application of Bayesian methods using a multivariate stochastic volatility model. The methods that have been used in empirical macroeconomics to estimate a
time-varying matrix t, notably in Cogley and Sargent (2005) and Primiceri (2005), require a decomposition
of this matrix of the form
t = Lt H t Lt ,
with Lt lower triangular and Ht diagonal. Using such factorization, it is possible to draw blockwise from the
distribution of covariance states (Lt), and from the distribution of volatility states (Ht). In this case, the measurement equations are given by Ltut=et and et=Htt, which correspond to (2) and (3) above. Note also that the
variables in the i-th measurement equation following from Ltut=et, that is ujt with j<i, are predetermined.
Hence, once independence between the states belonging to different equations is assumed, the normal linear
3Primiceri (2005) suggests a more general procedure in case several factorizations, i.e., orderings of the variables, appear plausible. This is to impose a prior on each of them, and then to average the results obtained on the basis of posterior probabilities.
4Except for the initial state of log dt whose covariance matrix is set to a multiple of the identity.
b
5The corresponding value for Qd was set to (0.01)2 and the ones for Q i to (0.1)2, following Primiceri (2005).
6This is implemented in such a way that the whole history of s generated at step 1 is discarded, in case the condition is not met
at least for one t.
M.C. Pereira and A.S. Lopes: Time-varying fiscal policy in the US163
implemented, with the simulation period extended by 1 year at a time. The starting date is always 1960:1;
the first ending date is 1965:2, and the last one 2009:2. The full set of iterations is thus repeated 45 times. For
each ending date, 30,000 iterations of the Gibbs sampler are run, after a burn-in period of 5000, and every
5th iteration is kept. The implied impulse-responses for each of the kept draws (6000) are computed, and we
report statistics of the distribution of those responses.
At the end of Appendix B we also report results concerning the autocorrelation functions of the draws,
which give an indication about the convergence properties of the algorithm. These autocorrelations are generally low, indicating that the chain mixes well.
NH
Joint
NH
Variance
QLR
Coeffs.
QLR
Variance
Net taxes
Expenditure
GDP deflator
GDP
0.16
0.01
0.00
0.01
0.07
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.73
0.00
0.00
0.00
p-Values of the Nyblom-Hansen (NH) test for driftless random-walk coefficients and variance (1st column) and variance only
(2nd), and p-values of the QLR test for a single break of unknown timing in the coefficients (3rd) and variance (4th). The usable
sample is 1948:2 to 2009:2 and the break search dates for the QLR test are located between 1963:2 and 1994:3.
break in the variance than in coefficients (and a similar picture is observed for the prices equation). This is
consistent with the findings of the literature on the Great Moderation that regime changes affected first and
foremost the volatility of shocks [see Stock and Watson (2002)]. Furthermore, our estimate of the break date
in (conditional) volatility is also consistent with most previous estimates [see, for instance, Kim and Nelson
(1999a), McConnell and Perez-Quiros (2000) and Stock and Watson (2002)].
At the usual 5% level, the Nyblom-Hansen test does not reject the parameter constancy hypothesis for
the net taxes equation. The results from the QLR test are partly contradictory with this, since they do reject
the null of constant coefficients, with the evidence cumulating in the second half of the sample. It might be
that instability in the coefficients of this equation is more of the single break type, and thus best captured by
Break in coefficients
Break in variance
250
200
150
100
5% CritVal
50
0
60
50
40
30
20
10
0
1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993
5% CritVal
1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993
Break dates
Break dates
Expenditure equation
250
60
50
40
30
20
10
0
200
150
100
50
Expenditure equation
5% CritVal
0
1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993
5% CritVal
1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993
Break dates
Break dates
250
60
50
40
30
20
10
0
200
150
100
50
5% CritVal
0
1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993
5% CritVal
1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993
Break dates
Break dates
GDP equation
250
60
50
40
30
20
10
0
200
150
100
50
GDP equation
5% CritVal
0
1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993
5% CritVal
1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993
Break dates
Break dates
M.C. Pereira and A.S. Lopes: Time-varying fiscal policy in the US165
the QLR statistic. As regards the variance, the evidence is reversed since only the Nyblom-Hansen test signals
some instability (although not significant at the 5% level).
As a whole, the results of the tests clearly support the use of a specification with time-varying parameters against a fixed-parameter one. Moreover, they call for a model that accommodates stochastic volatility.
Further still, the results of the QLR statistic indicate different break timings, depending on specific equations
and parameters, and not a generalized regime change affecting all equations at the same point in time. In
this context, a model with time-varying parameters appears superior to the traditional split- or rolling-sample
estimates of a fixed-parameter model.
5 Results
5.1 Data
Recall that our baseline specification includes four variables: taxes net of transfers, government expenditure (consumption plus investment),7 GDP and inflation. We also estimate a specification including private consumption.
Taxes net of transfers, government expenditure, output, and private consumption are in loglevels, in real and
per capita terms. To facilitate a comparison with previous (fixed-parameter) fiscal SVAR literature, we detrend all
these variables prior to estimation by regressing them on a second order polynomial in time. However, we have
also carried out simulations with series in loglevels and the results (available on request) generally make little
difference, except in a few details which are noted below. Inflation is calculated as the change in log GDP deflator at annual rates. The data are on a quarterly basis, seasonally adjusted, and the lag length of the system is set
to 2, the same value as in previous studies with TVP-VARs. A short lag length prevents the simulation procedure
from becoming too heavy, as it reduces considerably the size of the vector of coefficient states (for instance, in the
benchmark system, from 68 elements with four lags to 36 elements with two lags). In fact, we found that such
reduction has a very large impact (a more than proportional one) on the running time of simulations. Note that,
in time-invariant settings, four lags are usually considered [sometimes more, for instance, Mountford and Uhlig
(2009) use six lags]. This shorter number of lags we use could conflict with the assumption that disturbances t are
serially uncorrelated. In Section 6 on robustness we show that in our application this is not an issue, since results
under two and four lags show only small differences. For the sake of comparison with previous studies, we also
estimate a time-invariant version of our model over a rolling-sample, and adopt a lag length of 4 in this instance.
Expenditure
0.20
0.20
0.15
0.15
0.10
0.10
0.05
0.05
-0.00
-0.00
-0.05
-0.05
-0.10
-0.10
-0.15
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-0.20
1980
2000
1980
2000
undertaken around such episodes (having or not antirecessionary motivations) concerned taxes or transfers,
none of them spending. Such pattern did not change much with the last recession: out of the overall fiscal
stimulus undertaken in response to it, totaling 1067 billion dollars, only 147 billion went to infrastructure
and other spending (Blinder and Zandi 2010, table 10). The episodes of increase in defense spending that
have been studied by the event study approach (Edelberg, Eichenbaum, and Fisher 1999) do not give raise to
spikes in the shock series, possibly because they are spread over a number of quarters.
We now analyze the consistency of the estimated net tax shocks with the narrative accounts of tax policy
in the US. For this task, we use in particular the information available in Romer and Romer (2008), featuring
a detailed description, quantification and timing of tax policy actions until the mid-2000s. In doing this, some
remarks are in order. The structural shocks in SVARs are supposed to capture deviations from systematic policy
(automatic and discretionary responses to the business cycle). If there is, say, a tax rebate in the course of a recession, one may expect it to pass on to a greater or a lesser extent to the shock series (depending on the part of it
assigned in the estimation to the systematic response). The advantage of the TVP specification in comparison
to standard VARs is the added flexibility to adapt parameter estimates to temporal variation in those responses.
In any case, this differs from the narrative approach (Romer and Romer 2010) in which the analyst would classify
the entire tax rebate as endogenous or exogenous according to the assessed intentions of politicians.
One can pinpoint three occasions in which the estimated net tax shocks shown in Figure 2 were (in absolute terms) particularly large. The first one is around the 19731975 recession with a large negative spike in
1975Q2, which captures the Nixon tax rebate. The second one coincides approximately with the 2001 recession, and consists of two negative spikes, in 2001:3 and 2002:1, reflecting the tax cuts put in place by the Bush
II Administration under the Economic Growth Tax Relief Reconciliation Act of 2001. The third one generally
matches the enhanced activism of policy around the 20082009 recession, with three negative spikes in
2008Q2, 2008Q4 and 2009Q1. The first spike is contemporaneous with the 2008 tax rebate which took place
from April to July of that year (Congressional Budget Office 2009). The one in 2009Q1 coincides with the initial
impact of the American Recovery and Reinvestment Act (ARRA) of 2009. Note that this package was passed in
early 2009 and, according to the Bureau of Economic Analysis figures,8 there is some impact in government
8See Effect of the ARRA on Selected Federal Government Sector Transactions, on the BEA website at http://www.bea.gov/
recovery/index.htm?tabContainerMain=1.
M.C. Pereira and A.S. Lopes: Time-varying fiscal policy in the US167
accounts already in the first quarter, followed by a much larger one in the second (the estimated 2009Q2
shock is negative as well, albeit much smaller). Nevertheless, the magnitude of the 2009Q1 spike is so large
as to suggest that, beyond the impact of ARRA, net taxes were abnormally hit by the recession in that quarter.
It is worth noting that in a number of occasions negative shocks were followed by large positive ones
(notably in the quarters following the Nixon and the 2001 tax rebates). This has to do with the one-off nature
of tax rebates (affecting, say, one or two quarters only). The own lags in the net taxes equation lead the systematic part of the VAR to predict a decrease in revenue in the following quarters that does not materialize
because revenue returns to the normal level. More generally, temporary tax relief and expenditure packages
may lead also to offsetting shocks in the phasing out stage. There is one important tax policy episode that
does not show up in Figure 2 and this is the Reagan tax cuts, apparently fully captured in the estimation as an
automatic reaction to the 19811982 recession. Actually, the decrease in net taxes in the course of that recession was much smaller than in the other protracted recessions (see Section 5.6 for more discussion on this).
5.0
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Impulse: Expenditure
contemporaneous
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Impulse: Expenditure
after 1 year
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after 2 years
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after 3 years
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1970 1980 1990 2000
Figure 3Time-profile of output responses Bayesian simulation of a model with time-varying parameters.
9We follow the usual practice of presenting a simplified version of impulse-responses, in which the response for shocks at t is a
function of the parameters estimated for that date all steps ahead.
M.C. Pereira and A.S. Lopes: Time-varying fiscal policy in the US169
strongly in the recent contraction. Note that the multiplier changes from 0.8 in 2008 to 1.1 in 2009. It is
worth mentioning that when the model is estimated in loglevels this added policy effectiveness in the course
of the most recent recession becomes more noticeable. As regards expenditure shocks, the responses remain
more or less flat during recessionary episodes.
We now compare our findings with those presented in Kirchner, Cimadomo, and Hauptmeier (2010),
where a similar type of model is used for the euro area. They identify shocks to spending only, ordering them
before all the other variables (an identification assumption we also make), and report responses from 1980
on. Concerning the amount of time-variation captured, their results are equally compressed as ours, or even
somewhat more.12 Otherwise, both the level and profile of their responses differ from the ones in this paper.
They get a decrease in the size of the spending multiplier starting from the late 1980s, a period in which we
get stability of the response. Furthermore, their 1-year-ahead multiplier is below ours: marginally positive
(always lower than 0.5) until 2000 and slightly negative thereafter.
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after 1 year
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after 2 years
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Figure 4Time-profile of output responses rolling-sample estimates of a model with fixed parameters.
12The reason may be that, although Kirchner, Cimadomo, and Hauptmeier (2010) do not impose the stability condition, they use
a smoothed variant of the simulation procedure. We use a filtered variant instead.
13These are computed as follows. A time-invariant reduced form VAR is estimated for each of the rolling-samples. On the basis
of the point estimate for the covariance matrix, one draws firstly for this matrix, assuming a inverse-Wishart distribution. The
structural decomposition is applied to each draw. At the same time, one draws for the vector of coefficients, assuming a Gaussian
distribution, conditional on the covariance matrix previously drawn. The implied impulse-responses are obtained on the basis of
1000 draws and the relevant statistics computed.
14It is hard to blame the size of the rolling window (25 years) for this instability. For instance, although in a simpler context,
Stock and Watson (2007) use rolling samples with only 10 years. The uncertainty surrounding the point estimates in Figure 4 is
not unusually large for VAR standards.
M.C. Pereira and A.S. Lopes: Time-varying fiscal policy in the US171
-2
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-4
1970 1980 1990 2000
Impulse: Expenditure
after 1 year
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after 2 years
Impulse: Expenditure
after 3 years
4
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Impulse: Expenditure
contemporaneous
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1970 1980 1990 2000
Figure 5Time-profile of private consumption responses Bayesian simulation of a model with time varying parameters.
assumptions.15 It is worth noting that the consumption multipliers computed on the basis of the time-invariant
rolling sample (not shown) parallel those for output in Figure 4. In the case of expenditure shocks, they fluctuate
a lot, being generally positive, but assuming negative values between the mid-1980s and the mid-1990s.
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Net taxes
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M.C. Pereira and A.S. Lopes: Time-varying fiscal policy in the US173
with figures slightly over 1% and essentially show a decreasing trend throughout the period considered, to
a value around 0.4. In order to put these figures into context, we first calculate the implied semi-elasticity
of the deficit (as a percentage of output) to the output gap, a common indicator of fiscal policy responsiveness.18 This semi-elasticity fluctuates in the range from 0.3 to 0.5 until the 1980s and from 0.5 to 0.6 in the last
two decades. The overall increase in responsiveness we get is consistent with previous findings, as in Taylor
(2000). In particular, our figures broadly match the response of the surplus to the output gap presented in
this study (0.32 for the sample 19601982 and 0.68 for the sample 19831999).
Figure 6 shows in particular two jumps in the strength of net tax responses coinciding, respectively, with
the 19731975 and the 20082009 recessions, signalling an enhanced countercyclical action around these
recessionary episodes. Moreover, as previously observed, in the course of the last recession there was a large
increase in the calibrated elasticity.
The behavior of expenditure is procyclical. The responses are generally significant; the lower confidence
band becomes slightly below the x-axis from 1999 on but only marginally. In a regression of discretionary
Federal expenditure on output gap, Auerbach (2002) finds evidence of countercyclicality, albeit statistically
insignificant. The difference to our results may be due to the inclusion of the spending of state and local
government, which has been found to follow a procyclical pattern.
We now move on to non-systematic policy. Figure 7 presents the evolution of the volatility of structural
fiscal shocks since the mid-1960s which is, of course, closely related with the size of the shocks depicted in
Figure 2. As far as net taxes are concerned, there was a rise in this volatility from the early to mid-1970s, with a
peak around 1975. Such peak reflects, as explained in Section 5.2, the large countercyclical one-off measures
around the 19731975 recession, which pass on to the shocks despite captured by the systematic part of the
VAR to some extent, as documented above. Volatility goes progressively down, to a minimum around 2000,
and subsequently there is a large increase toward the end of the sample. This recent evolution reflects firstly
Net taxes
Expenditure
8
Percentage points
Percentage points
2
1970
1980
1990
2000
1970
1980
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2000
18This is obtained as the difference between the products of the response of each fiscal variable and the ratio of that variable to
GDP. Note that our semi-elasticity actually refers to the primary deficit, since the definition of fiscal variables we adopt excludes
interest outlays.
6 Robustness
In this section we briefly present some robustness exercises that address issues suggested by the analysis of
benchmark results.
Shutting down sources of time-variation. We shut down time-variation to a certain degree by imposing
restrictions on the covariances of disturbances in transition equations (5), (6) and (7). This exercise allows us
to evaluate whether the large amount of uncertainty surrounding the responses narrows down. Specifically,
we first impose a block-diagonal structure on matrix Q, where each block corresponds to a given equation
(note that the covariance states are already drawn assuming this kind of block-diagonality), and then impose
a fully diagonal structure on all state covariance matrices: Q, Qbi and Qd.
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Figure 8Output responses with full diagonality of all state covariance matrices.
M.C. Pereira and A.S. Lopes: Time-varying fiscal policy in the US175
Figure 8 shows that when full diagonality is imposed both the central estimates and uncertainty around
them hardly change in comparison to the benchmark results (the same holds for block diagonality). It appears,
therefore, that uncertainty is basically related to the variances of the innovations in the state equations rather
than to the covariances. Note that a positive variance of state innovations is the essential ingredient of the model.
Modifying prior distributions of the hyperparameters. The scale factors for the inverse-Wishart distributions of hyperparameters are important for posterior inference, but unfortunately the choice of the respective
values by the researcher is much arbitrary. In the benchmark specification we set the factor for the coefficient
states (k) at 0.01 and for the covariance states (kb) at 0.1 (see Section 3.1). Figure 9 shows the results with
k=kb=0.1, which means more time-variation a priori for the coefficient states, accounting for 10% of their
standard deviation. The average GDP responses at longer horizons (particularly 3 years) become more unstable and the confidence bands widen considerably. The median responses, however, remain largely unaffected even for longer horizons. We also experimented with k=kb=0.01 (not shown) i.e., feeding in less
time-variation a priori but this hardly changed the benchmark results. Overall, our findings seem robust to
changing scale factors for the inverse-Wishart hyperparameter distributions.
Changing the lag length to 4 in the TVP specification. The results presented throughout the paper come
from a VAR specified with two lags, mainly in order to reduce the number of parameters in (and the time
consumed by) the simulation procedures. This has only a small impact on the results vis--vis a specification with four lags, the commonest in a fixed-parameter context (Figure 10). The figure indicates that output
responses remain approximately unchanged, except that the initial weakening of the expenditure multiplier
is now more marked for longer horizons. Moreover, this is accompanied by a further increase in uncertainty.
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2.5
0.0
0.0
0.0
0.0
-2.5
-5.0
5.0
-2.5
-5.0
1970 1980 1990 2000
5.0
-5.0
1970 1980 1990 2000
Impulse: Expenditure
after 1 year
5.0
Impulse: Expenditure
after 2 years
5.0
2.5
0.0
0.0
0.0
0.0
-2.5
-5.0
-2.5
-5.0
1970 1980 1990 2000
2.5
2.5
2.5
-2.5
Impulse: Expenditure
after 3 years
-2.5
-5.0
1970 1980 1990 2000
-2.5
-5.0
1970 1980 1990 2000
Impulse: Expenditure
contemporaneous
2.5
2.5
-2.5
2.5
5.0
-5.0
1970 1980 1990 2000
Figure 9Output responses in a TVP-VAR with scale parameters k=0.1 and kb=0.1.
5.0
5.0
5.0
2.5
0.0
0.0
0.0
0.0
-2.5
-5.0
5.0
-2.5
-5.0
1970 1980 1990 2000
5.0
-5.0
1970 1980 1990 2000
Impulse: Expenditure
after 1 year
5.0
Impulse: Expenditure
after 2 years
5.0
2.5
0.0
0.0
0.0
0.0
-2.5
-5.0
-2.5
-5.0
1970 1980 1990 2000
2.5
2.5
2.5
-2.5
Impulse: Expenditure
after 3 years
-2.5
-5.0
1970 1980 1990 2000
-2.5
-5.0
1970 1980 1990 2000
Impulse: Expenditure
contemporaneouts
2.5
2.5
-2.5
2.5
5.0
-5.0
1970 1980 1990 2000
7 Conclusions
In this paper we presented the results of the simulation of a fiscal policy VAR with time-varying para
meters, embedding a non-recursive, Blanchard and Perotti-like identification scheme into a Bayesian
simulation procedure. Our evidence suggests that policy effectiveness has come down substantially over
the period considered, 1965:2 to 2009:2, as far as net taxes are concerned. On the expenditure side,
a fading of the effects of policy shocks is detected as well, but of a much smaller magnitude. Private
consumption responds negatively to net tax shocks and very little to expenditure shocks. In this case,
the effects are found to have remained stable over time. We have also addressed time-variation in the
conduct of fiscal policy, finding that overall endogenous net taxes have increasingly reacted to output,
while the variance of the respective exogenous component has fluctuated much and been particularly
high in the recent years.
With the exception of the stance of the business cycle, we do not perform any exercise relating the
documented time-profile of the fiscal multipliers to possible underlying factors. Many other hypotheses
have been put forward in this context, as it is well known, such as the degree of openness of the economy
or the easing of liquidity constraints. In order to investigate them in a rigorous manner, one would have to
set up a non-linear system whose specification and simulation are left to further research.
M.C. Pereira and A.S. Lopes: Time-varying fiscal policy in the US177
Appendices
A Definition of variables and data sources
All the data we use are taken from the National Income and Product Accounts, NIPA, which are freely available in the website of the Bureau of Economic Analysis. Fiscal data are from NIPAs table 3.1., Government
Current Receipts and Expenditures: data on the components of government consumption, including the
breakdown defense/non-defense, are from NIPAs table 3.10.5, Government Consumption Expenditures and
General Government Gross Output; data on social benefits including unemployment and health-related benefits are from NIPAs table 3.12., Government social benefits (annual data, the share for the year as a whole was
assumed for the quarter). Gross domestic product is from NIPAs table 1.1.5., Gross Domestic Product. Gross
domestic product deflator is from NIPAs table 1.1.4., Price Indexes for Gross Domestic Product. Population is
from NIPAs table 2.1., Personal income and its Disposition.
Taxes =Personal current taxes + Taxes on production and imports + Taxes on corporate income + Contributions for government social insurance + Capital transfer receipts (the latter item is composed mostly by gift
and inheritance taxes).
Transfers = Subsidies + Government social benefits to persons + Capital transfers paid Current transfer
receipts (from business and persons).
Net taxes =Taxes Transfers.
Purchases of goods and services = Government consumption Consumption of fixed capital19 + Government investment.
xt=Xtt+ut,
t = t1 + et ,
(A1)
(A2)
19Consumption of fixed capital is excluded on two grounds. Firstly, there are no shocks to this variable, which is fully determined
by the existing capital stock and depreciation rules. Secondly, from the viewpoint of the impact on aggregate demand, it is the cost
of capital goods at time of acquisition (already recorded in government investment) that matters and not at time of consumption.
T | yT , T , Q ~ N ( T |T , PT|T )
(A3)
and
t +1
), t = 1, , T 1,
(A4)
where the conditional mean and variance in expression (A3), T|T and PT|T , can be obtained as the last iteration of the usual Kalman filter, going forward from
t|t = t|t1 + Pt|t1 Xt ( Xt Pt|t1 Xt + t ) 1 ( y t Xt t|t1 ),
Pt|t = Pt|t1 Pt|t1 Xt ( Xt Pt|t1 Xt + t ) 1 Xt Pt|t1 ,
t|t1 = t1|t1 ,
Pt|t1 = Pt1|t1 + Q ,
. These initial values are given by the mean and covariance matrix
starting from the initial values 0|0 and P0|0
of the prior, 0 ~ N ( , 4V ( )), obtained as coefficient vector and covariance matrix from the OLS estimation
of the reduced-form system (1) for the training subsample 1947:11959:4. The elements in T1 are drawn from
(A4) going backward. That is, T1 is drawn conditional on the realization of T , T2 conditional on the realization of T1 and so on up to 1. The conditional mean and variance in (A4) are given by
t +1
t +1
(A5)
(A6)
2
), d33 denoting the third element in the main diagonal of Dt,
where b3,t=[32,t], e p , t ~i.i.d.N (0, d33
b
3
b3
b3
et ~ i.i.d.N (0, Q ), and ep,t and ei , t are independent. This simulation yields a history bT3 and, conditional
on it, a history eTp .
M.C. Pereira and A.S. Lopes: Time-varying fiscal policy in the US179
unt , t a14
uy , t = [ e g , t e p , t ] b 1, t + ent , t ,
b 1, t = b 1, t1 + etb 1 ,
(A7)
(A8)
where b1, t=[ 12,t 13,t], e p , t ~i.i.d.N (0, d112 ), d11 denoting the first element in the main diagonal of Dt,
etb 1 ~ i.i.d.N (0, Q b 1 ), and ent, t and etb 1 are independent. This simulation yields a history bT1 and, conditional
on it, a history entT .
The third state-space problem is
(A9)
(A10)
2
where b4, t=[ 41, t42, t43, t], ey , t ~i.i.d.N (0, d44
), d44 denoting the fourth element in the main diagonal of Dt,
b4
b4
b4
et ~ i.i.d.N (0, Q ) and ey, t and et are independent. This simulation yields bT4 and, conditional on it, a
history eTy .
The simulations for each of the three state-space models are conducted precisely in the same way as
described for Step 1, on the basis of the distributions corresponding to (A3) and (A4) above. The initial values
b
, 4V ( b
)).
for the Kalman filter, bi, 0|0 and P0|0i , are from the mean and covariance matrix of the priors: bi , 0 ~ N ( b
i
i
These parameters are obtained from estimating by OLS the structural decomposition (4) for the training subsample 1947:11959:4.
(A11)
(A12)
where et+ =log( et2 +0.001) denotes the logarithm of the square of each element of et plus an offsetting constant equal to 0.001, log dt denotes the elementwise logarithm of the vector dt and log( t2 ) the elementwise
logarithm of the vector t. Furthermore, etd ~ i.i.d.N (0, Q d ) and, since t and etd are independent, the same
applies to log t2 and etd . 20
The algorithms for the Gaussian linear state space model cannot be directly applied in this case, because
the disturbances log i2, t , i= 1, , 4, are not Gaussian. The distribution of these disturbances can, however, be
approximated using a mixture of seven Gaussian densities (see Kim, Shephard, and Chib 1998 for the details):
7
(A13)
20This description of the simulation procedure assumes that the covariance matrix of the state innovations, Qd, is unrestricted
and thus the volatility states are drawn jointly. One could alternatively assume a diagonal Qd matrix i.e., independent state innovations , in which case the simulations would be carried out equation by equation. We experimented with both possibilities
and the results were similar.
(A14)
Therefore, a history log dT can be drawn conditional on sT, in addition to xT, T, BT (making eT or et+T observable) and the hyperparameters in Qd. It is straightforward to adapt the formulae in Step 1 to this end. The
initial values for the Kalman filter are, as previously, from the mean and covariance matrix of the prior which
are the log standard deviations of the structural shocks
, I ). The figures in log d
is given by log d0 ~ N ( log d
n
from the abovementioned estimation of the system in the training subsample.
(A15)
21In the five-variable system including private consumption, T0 is set to 56. This is equal to the size of the vector t plus 1, the minimum number of degrees of freedom for the prior to be proper (and exceeds the number of observations in the training sample).
M.C. Pereira and A.S. Lopes: Time-varying fiscal policy in the US181
1.00
1.00
0.75
0.75
0.50
0.50
0.25
0.25
0.00
0.00
-0.25
(B2)
(B3)
-0.25
500
1.00
(B1)
1000
1500
500
1.00
0.75
0.75
0.50
0.50
0.25
0.25
0.00
0.00
-0.25
1000
1500
-0.25
500
1000
1500
500
1000
1500
1.00
0.75
0.75
0.50
0.50
0.25
0.25
0.00
0.00
-0.25
-0.25
200
1.00
Hyperparameters
1.00
400
600
800
1000
100
200
300
400
500
600
Volatility states
0.75
0.50
0.25
0.00
-0.25
100 200 300 400 500 600 700
(B4)
Note that equation (B2) has no unknown parameters. In order to reparameterize equation (B3), one has
to replace utg as given by (B2) in it, yielding
utp = 32 etg + et+ p ,
(B3)
y
utnt a14
ut = 12 etg + 13 t+ p + etnt ,
(B1)
(B4)
1
1
1
41 =(1 a41a14
) a41 ,
42 = (1 a41a14
) [( a41a13 + a42 a23 + a43 ) 32 + a41b12 + a42 ], 43 = (1 a41a14
)
where
+y
y
It is easy to check that the set of equations implied by scheme (4) in Section 2 consists of (B1), (B2), (B3)
and (B4).
M.C. Pereira and A.S. Lopes: Time-varying fiscal policy in the US183
Acknowledgement: We are grateful to Lus F. Costa, participants in ESEM 2011, Oslo, the editor and two anonymous referees for helpful comments and suggestions. Both authors gratefully acknowledge financial support from Fundao para a Cincia e Tecnologia (FCT) through Programa POCTI.
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