Browsing by Subject "business cycles"

The debate on the topic of the merits of fiscal policy has re-emerged due to the financial crisis of 2008-10 and the effect of the zero lower bound on monetary policy. New research has added new models and identification methods to the growing body of literature on fiscal multipliers. The motivation for the paper was to investigate the effects of fiscal policy shocks using a structural VAR. The main goal has been to estimate the spending and tax multipliers for Estonia. Estonia was one of the first countries to put forth austere fiscal consolidation measures in response to the aforementioned crisis. Thereafter, it has become a peculiar case study for critics and advocates of austerity, as it managed to grow its way through the financial crisis despite significant austerity measures. A major challenge when using a SVAR is the identification of fiscal policy shocks. Due to the simplicity of the method and the lack of narrative data on fiscal measures, I opted to estimate the SVAR using the Cholesky decomposition. The estimated multipliers are small in magnitude, same as mostly found in the literature based on the Blanchard-Perotti identification scheme. However, the signs of the estimates are reversed compared to the usual. Estimation results show positive spending shocks to be contractionary and positive tax shocks to be expansionary. These can be interpreted as negative fiscal multipliers, as found in papers such as Giavazzi and Pagano (1990) and Alesina and Ardagna (1998). This suggests that fiscal austerity could be expansionary in the Estonian economy. Another explanation for the results is the possibility that the the spending-savings decisions of the Estonian firms and consumers are consistent with Ricardian equivalence. Furthermore, the small sample size and the possibility of a misspecified model are other important aspect to keep in mind when interpreting the results. Thus, further investigation is warranted. The study could be extended in many different directions. For instance, one could attempt to estimate state-dependent multipliers, control for fiscal foresight, test different SVAR identification schemes, include monetary policy interactions with fiscal policy, and extending the research to a panel study covering all the Baltic States. The latter could perhaps offer a way out of the small sample size problem, considering the similarity of Estonian and other Baltic economies.