Proper Case study about Fiscal Policy

1. Presentation On:-
“Fiscal Policy ”
Submitted To: Submitted
By:
Mr. Karan Sabharwal Satyajit
Chatterjee(BM-171055)
Anshika Jain (BM-
171042)
Suman Dutta (BM-
171060)
Bodhi Gargeshya
(BM-171050)

2. Research Paper:- 1
WHAT ARE THE EFFECTS OF FISCAL POLICY
SHOCKS?
BY- Andrew Mountford & Harald Uhlig
 Abstract:-

An effect of fiscal policy using vector
autoregressions is a new approach and
proposed by Andrew Mountford and Harald
Uhlig. This approach does not require the
variables to fiscal policy which is set to zero or
need any additional information such as the
timings of wars, in order to identify fiscal policy
shocks. It is a purely vector autoregressive
approach which can be universally applied.

3.  The advantages of the approach that it is able to model
the effects of announcements of future changes in fiscal
policy and that it is able to distinguish between the
changes in fiscal variables caused by fiscal policy shocks
and those caused by business cycle and monetary policy
shocks. They applied the method to US quarterly data
from 1955-2000 and obtain interesting results. Their key
finding is that the best fiscal policy to stimulate the
economy is a deficit-financed tax cut and that the long
term costs of fiscal expansion through government
spending are probably greater than the short term gains

4. Literature Review:-
 Blanchard and Perotti (2002):- Their paper characterizes the
dynamic effects of shocks in government spending and taxes on
economic activity in the United States in the postwar period. It does
so by using a structural VAR approach that relies on institutional
information about the tax and transfer systems and the timing of tax
collections to identify the automatic response of taxes and spending
to activity, and, by implication, to infer fiscal shocks.
 Fatas and Mihov (2001a,b):- The aim of their paper is to test
whether differences in the results can be explained by different VAR
specifications or they are an outcome of the different methodologies
implemented. In order to evaluate they build a common VAR and
then they compare the impulse responses obtained using different
methodologies. They found that if the order of variables in the
recursive approach is well selected, there are only minor differences
between the impulse responses obtained using the recursive
approach and the Blanchard-Perotti approach, both for government
expenditure and government revenue shocks.

5.  Ramey and Shapiro (1998):- Their paper analyzes the
effects of sector specific changes in government spending
in a two-sector dynamic general equilibrium model in
which the reallocation of capital across sectors is costly.
 Eichenbaum and Fisher (2003):- Their paper
investigates the response of hours worked and real wages
to fiscal policy shocks in the U.S. during the post World
War II era. They 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

6. Methodology:-
 The best fiscal policy to stimulate the economy is deficit-
financed tax cut.
 A weak economic stimulation is done by deficit spending shock
 Interest rates rise due to government spending on shocks for
both residential and non-residential investments.
 Business cycle shock is very important to control during
analyzing the consequences of fiscal policy.
 US national income data components are gathered from
National Income and Product Accounts (NIPA).
 This is publicly available by the Bureau of Economic Analysis.
 Few components are taken from Federal Reserve Board of St.
Louis’ website and those are interest rate, producer commodity
price index and adjusted reserves.

7. Conclusion:-
 The method of Uhlig (2005) has presented a new
approach for distinguishing the effects of fiscal policy
shocks. The methods used are information in
macroeconomics time series of the vector autoregression
together with minimal assumptions that helped to identify
the fiscal policy shocks. They have analyzed three types of
policy shocks and those are deficit-financed spending
increase, and a balanced budget spending increase and a
deficit-financed tax cut. Both types of spending shock had
the effect of crowding out investment. Higher debt
burdens may result to long-term consequences which are
worse than the short increase in GDP.

8. Research Paper:- 2
LARGE CHANGES IN FISCAL POLICY:
TAXES VERSUS SPENDING
BY- Alberto Alesina & Silvia Ardagna
 ABSTRACT:-
In cases of both fiscal stimuli and fiscal adjustments from 1970 to
2007 in OECD countries, the evidence on episodes of large
impacts in fiscal policy has been examined. The chances of
growth are more likely to increase if fiscal stimuli are based on
tax cuts than those based on spending increases. The chances
to reduce deficits and debts over GDP ratios are more if fiscal
adjustments are based on no tax increases and spending cuts
than those based on tax increases. In addition, adjustments on
the spending rather than adjustments on tax are less likely to
create recessions. With simple regression analysis these results
have been confirmed

9. LITERATURE REVIEW:-
 Giavazzi and Pagano (1990) were the first to argue that fiscal
adjustments (deficit reductions) large, decisive, and on the
spending side could result in economic expansion. This was the
case of Ireland and Denmark in 1980s, Giavazzi and Pagano
studied episodes and Alesina and Ardagna discussed and
analyzed those.
 Romer and Romer (2007) use a variety of narrative sources and
find that the taxation increase by 1% of GDP reduces output in
the next 3 years by a maximum of approximately 3% and there
is smaller effect when the only changes in taxes considered are
those taken to reduce past budget deficits.
 Structurally VAR techniques are used by Blanchard and Perotti
(2002) to identify exogenous changes in fiscal policy and to
estimate fiscal multipliers both on the tax side and on the
spending side. They find that output and consumption are
increased and investment is decreased by positive government
spending shocks. Whereas positive tax shocks have a negative
impact on output, consumption and investment.

10. METHODOLOGY:-
 There is very simple approach. Major changes in fiscal policy
have been identified, either expansionary (deficit increases or
surplus reductions) or vice-versa. The decision about whether
to apply these policy changes is derived to the state of the
finances and of the economy. However, it is assumed that the
decision whether to act or not to act on the spending side or
revenue side is dictated by political preferences and political
bargaining at least up to a point which is external to the
economy and is generated by ideological or policy preferences.
If the debates following major fiscal changes are looked and the
high degree of uncertainty about the size of fiscal multipliers is
considered, then this assumption seems to be reasonable. Thus
the emphasis is on the effects of different composition of fiscal
stimuli and adjustments. The size of fiscal multipliers is not
computed. The effects of different compositions of major fiscal
changes are compared

11. CONCLUSION:-
 It is worth to speculate the fiscal stance in the United States. The
result of bailouts of various types of the financial sector is a very
large portion of 12% of GDP deficit. About two-third of the fiscal
package which is decided to take the economy out of recession is
constituted by increases in spending, including transfers and
government consumption. According to the results, fiscal stimuli
based on tax cuts are more likely to be growth enhancing than those
on the spending side.
 For fiscal adjustments, spending cuts are much more effective than
tax increases in stabilizing the debt and avoiding economic
downturns. The analysis of the present paper suggests that it is
difficult to achieve fiscal stability unless primary spending is cut
because spending may rise faster than tax revenue. But the question
is which primary activity can be cut? Large increases in spending has
been applied in health care reforms, social security has been in the
background but has not disappeared in the time of the crisis.
Spending on subsidies is required to overcome a relatively high
unemployment rate. A deficit of 7% of GDP up to 2020is predicted by
the Congressional Budget Office.

12. Research Paper:- 3
FISCAL POLICY AND GROWTH: EVIDENCE
FROM OECD COUNTRIES
BY- Richard Kneller, Michael F. Bleaney , Norman
Gemmell
 ABSTRACT:-
Is the evidence consistent with the predictions of endogenous
growth models that the Structure of taxation and public expenditure
can affect the steady-state growth rate? Much Previous research
needs to be re-evaluated because it ignores the biases associated
with Incomplete specification of the government budget constraint.
We show these biases to be substantial and, correcting for them

13. find strong support for the Barro model (1990,Government spending in a
simple model of endogenous growth. Journal of PoliticalEconomy 98 (1),
s103–117, for a panel of 22 OECD countries, 1970–95. Specifically wefind
that (1) distortionary taxation reduces growth, whilst non-distortionary
taxation doesnot; and (2) productive government expenditure enhances
growth, whilst non-productiveExpenditure does not.
LITERATURE REVIEW:-
According to the neoclassical growth model of Solow (1956) and
Swan (1956) if the government could influence the rate of
population growth, for example by reducing infant mortality or
encouraging child-bearing, this would not affect the long-run
growth rate of per capita income. In these models, tax and
expenditure measures that influence the savings rate or the
incentive to invest in physical or human capital ultimately affect
the equilibrium factor ratios rather than the steady growth rate.

14.  Barro (1990), King and Rebelo (1990) and Lucas (1990),
have extended the analysis of taxation, public expenditure
and growth, demonstrating various conditions under
which fiscal variables can affect long-run growth. In
endogenous growth models, investment in human and
physical capital does affect the steady-state growth rate,
and consequently there is much more scope in these
models for at least some elements of tax and government
expenditure to play a role in the growth process.
 According to Stokey and Rebelo (1995) recent estimates of
the potential growth effects of tax reform vary wildly,
ranging from zero to eight percentage points. There is no
Empirical evidence for this theory, but there are some
instruments using them they find out the steady growth
rate.

15.  METHODOLOGY:-
There is very simple approach. These public-policy
neoclassical growth models consign the role of fiscal policy to
one of determining the level of output. The steady-state
growth rate is driven by the exogenous factors of population
growth and technological progress, predictions from these
endogenous growth models are derived by classifying elements
of the government budget into one of four categories:
distortionary ornon-distortionary taxation and productive or
non-productive expenditures. Results are driven by the
classification of fiscal variables into one of four types. To these
we add the government budget surplus and revenues and
expenditures. Following Barro (1990), we treat 4 income and
property taxes as ‘distortionary’ and consumption taxes as
’non-distortionary’. Our data set covers 22 developed countries
for the period 1970–95, from two sources. Government budget
data come from the GFSY; remaining data are from the World
Bank Tables. An important feature of our methodology is that
we have taken full account of the implicit financing
assumptions associated with the government budget
constraint.

16. CONCLUSION:-
 Theory predicts that the impact of fiscal policy on growth
depends on the structure as well as the level of taxation and
expenditure. We find expenditures classified as non-productive
and tax revenues classified as non-distortionary to have equal
coefficients, and consequently we cannot reject the hypothesis
that these variables have a zero impact on growth, consistent
with the predictions of Barro (1990). When financed by some
combination of non-distortionary taxation and non-productive
expenditure, an increase inproductive expenditures
significantly enhances growth, and an increase in distortionary
taxation significantly reduces growth. This suggests that
considerable caution should be exercised in predicting the
precise growth effects of fiscal changes; further work should
seek to identify those magnitudes more reliably. Even our
lowest estimates suggest that increasing productive
expenditure or reducing distortionary taxes by 1% of GDP can
modestly increase the growth rate (by between 0.1 and 0.2%

17. Research Paper:- 4
IMPACT OF FISCAL POLICY ON ECONOMIC ACTIVITY
OVER THE BUSINESS CYCLE
By- Anja Baum & Gerrit B. Koester
 Abstract:-
 The findings have important applications for optimal
fiscal policy mix over the different stages of business
cycle.
 If there are negative output gap then fiscal multipliers
are at large and are very limited if there is positive
output gap.
 What would be should be the optimal fiscal policy
action depending on the size, timing and policy mix?
 Discretionary revenue policies, have limited impact.

18. Literature Review:-
 According to Buiter, in times of a positive output gap,
government expenditure can replace private expenditure.
 According to Drazer, the size and persistence of the fiscal
impulse influences the effects of fiscal policy.
 According to Blanchard, government fiscal policy shock
increases private consumption and GDP.
 According to Gali and Roeger fiscal policy can influence
income and consumption by tax curds or by increasing in
transfers.

19. Methodology:-
 Only 3 variables are concerned government spending,
government revenue and GDP
 For non-linear specification an additional variable ‘output gap’
is taken into consideration to differentiate between good and
bad economic time.
 Instead of starting the analysis in the first quarter, it was done
5years hence in order to avoid structural break due to policy
shift.
 IMF Multimod model, OECD interlinks are used
 The Hodrick-Presto filter has come to use to estimate output
gap
 Unemployment spending is taken as negative in the revenue
series

20. Conclusion:-
 The risks and effects of fiscal policy shocks can be
determined.
 The analysis suggests that fiscal steering of the economy
through revenue policies should only be considered in
times of a positive output gap.
 Results are not considered as clear policy advices, rather
considered as gradual differences in the impact of fiscal
policy based on the state of business cycle.
 Non-linear analysis shows far more strong and vigorous
behavior than linear analysis.