An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output
Olivier Blanchard, Roberto Perotti
Abstract
This paper characterizes the dynamic effects of shocks in government spending and taxes on U. S. activity in the postwar period. It does so by using a mixed structural VAR/event study approach. Identification is achieved by using institutional information about the tax and transfer systems to identify the automatic response of taxes and spending to activity, and, by implication, to infer fiscal shocks. The results consistently show positive government spending shocks as having a positive effect on output, and positive tax shocks as having a negative effect. One result has a distinctly nonstandard flavor: both increases in taxes and increases in government spending have a strong negative effect on investment spending.
Talks about the use of deterministic (linear, quadratic etc time trends) vs stochastic (“unit root with slowly changing drift”) trends. They talk about it a bit on page 1339.
Interesting that they added controls interacted with the lags, allowing for quarter-dependence of the relevant effects/coefficients. I think that’s fine in principle but could have been a random thing added in to make the results look better.