Browsing by Author "Virkola, Tuomo"

Fiscal policy is the only available sovereign macroeconomic stabilization tool for countries that have adopted a fixed exchange rate regime. Among these countries are the members of the euro zone that have adopted a common currency. However, there exists little empirical evidence on the effectiveness of fiscal policy measures under such an economic environment. The effects of fiscal policy shocks have been mostly studied in the United States or other non-European countries operating under flexible exchange rate regimes. This thesis studies the effects of discretionary fiscal policy shocks in small open economies under different exchange rate regimes. The empirical analysis is based on a structural vector autoregressive (SVAR) model that takes advantage of institutional knowledge on tax collection lags and automatic movements in government expenditure and net taxes. In particular, the thesis suggest that by estimating the effects of fiscal policy shocks in two structurally similar countries that have opted for different monetary policy regimes (Finland and Sweden) one can convincingly control for the economic environment and study the effect of exchange rate regime on fiscal policy transmission. Further, the thesis proposes to augment the baseline model with quarterly fiscal forecasts and to study the effects of fiscal policy under fiscal foresight, i.e., when economic agents may anticipate and respond to fiscal policy measures prior to their implementation. The results suggest that the effects of fiscal policy shocks depend on the exchange rate regime. The effects of fiscal policy shocks under a fixed exchange rate tend to be more expansionary when compared to a floating exchange rate regime. The quantitative estimates of the effects of fiscal policy shocks tend to be associated with notable uncertainty, but it is argued that the qualitative difference is robust to a variety of sensitivity tests. In addition, the thesis suggests that fiscal foresight may affect the identification of fiscal policy shocks and hence the estimated dynamic results within conventional SVAR models. The findings are consistent with previous fiscal policy literature that has considered fiscal policy shocks within different exchange rate regimes, but also with studies that have incorporated fiscal foresight into SVAR models.