When are the Effects of Fiscal Policy Uncertainty Large?

Benjamin Johannsen, a job market candidate from Northwestern, weighs in:

ABSTRACT: I argue that fiscal policy uncertainty can have large and adverse effects when the monetary authority is constrained by the zero lower bound on nominal interest rates. Using a new-Keynesian model with endogenous capital accumulation, I show that uncertainty about short-run and long- run fiscal policy can cause large falls in consumption, investment, and output when the zero lower bound binds, but has modest effects when it does not. I study uncertainty about the level of government spending and uncertainty about tax rates on consumption, dividends, wages, profits, capital, and investment. In my model, uncertainty about government spending and the wage tax rate has particularly large effects. I present empirical evidence indicating that shocks to policy uncertainty had larger effects on the U.S. economy during the Great Recession, a period in which the Federal Reserve’s policy rate has been at its effective lower bound, than in the preceding years.

About ozidar

I'm an Assistant Professor of Economics at the University of Chicago Booth School of Business and a Faculty Research Fellow at National Bureau of Economic Research. You can follow me on twitter @omzidar. http://faculty.chicagobooth.edu/owen.zidar/index.html
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