When Does Government Debt Crowd Out Investment? Joint with Shu-Chun S. Yang.
Journal of Applied Econometrics, forthcoming. We examine when government debt crowds out investment for the U.S. economy
using an estimated New Keynesian model with detailed fiscal specifications and
accounting for monetary and fiscal policy interactions. Whether investment is
crowded in or out in the short term depends on policy shocks triggering debt
expansions: Higher debt can crowd in investment for cutting capital tax rates or
increasing government investment. Contrary to the conventional view, no
systematic relationships between real interest rates and investment exist,
explaining why reduced-form regressions are inconclusive about crowding-out. At
longer horizons, distortionary financing is important for the negative
investment response to debt. Online Appendix.
Fiscal Limits: The Case of Greece.
Joint with Huixin Bi.
Journal of Applied Econometrics, forthcoming.
This paper uses Bayesian methods to estimate a real business cycle model
that allows for interactions among fiscal policy instruments, the stochastic
'fiscal limit,' and sovereign default. Using the particle filter to perform
likelihood-based inference, we estimate the full nonlinear model with
post-EMU data until 2010Q4. We find that 1) the probability of default on
Greek debt was in the range of 5% to 10% in 2010Q4 and 2) the 2011 surge in
the Greek real interest rate is within model forecast bands. The results
suggest that a nonlinear rational expectations environment can account for
the Greek interest rate path. Online Appendix.
Estimating Sovereign Default Risk.Joint
with Huixin Bi. American Economic Review Papers and Proceedings,
102(3), May 2012: 161-166 This paper uses Bayesian methods to estimate the sovereign default
probability for Greece and Italy in the post-EMU period. We build a real
business cycle model that allows for interactions among fiscal policy
instruments, sovereign default risk, and a "fiscal limit," which measures
the maximum level of debt the government is willing to finance. We estimate
the full nonlinear model using likelihood inference methods. Although we
find that Greece historically had a lower default probability than Italy for
a given debt level, our estimates suggest that the Italian government is
more willing to service debt than the Greek government.
Monetary and Fiscal Policy Interactions in the Post-War U.S. Joint with Shu-Chun S. Yang. European Economic Review,
55(1), January 2011: 140-164 A New Keynesian model allowing for both an active monetary and passive fiscal
policy (AMPF) regime and a passive monetary and active fiscal policy (PMAF) regime
is estimated to fit various samples from 1955 to 2007. We find that the U.S. data in the pre-
Volcker period strongly prefer an AMPF regime, even with a prior centered in the PMAF
region. However, the estimation is not very informative about whether the monetary authority’s
reaction to inflation is greater than one-for-one in the pre-Volcker period, as much
lower values can still preserve determinacy under passive fiscal policy. In addition, we find
that whether a PMAF regime can generate consumption growth following a government
spending increase depends on the degree of price stickiness. An income tax cut can generate
an unusual negative labor response if monetary policy aggressively stabilizes output growth.
Dynamics of Fiscal Financing in the United States. Joint with
Eric M. Leeper and Michael Plante. Journal of Econometrics, 156(2), June 2010: 304-
321 General equilibrium models that include policy rules for government spending, lump-sum transfers, and distortionary
taxation on labor and capital income and on consumption expenditures are fit to U.S. data under rich specifications of fiscal policy rules to obtain several
results. First, the best-fitting model allows many fiscal instruments to respond to debt. Second, responses of aggregates to fiscal policy shocks under rich
rules vary considerably from responses where only non-distortionary fiscal instruments finance debt. Third, in the short run, all fiscal instruments except
labor taxes react strongly to debt, but long-run intertemporal financing comes from all components of the government's budget constraint. Fourth, debt-financed
fiscal shocks trigger long lasting dynamics; short- and long-run multipliers can differ markedly.
Time-Varying Oil Price
Volatility and Macroeconomic Aggregates.Joint with Michael Plante.
*New draft coming soon We illustrate the theoretical relation among output, consumption, investment, and
oil price volatility in a real business cycle model. The model incorporates demand for
oil by a firm, as an intermediate input, and by a household, used in conjunction with a
durable good. We estimate a stochastic volatility process for the real price of oil over
the period 1986-2011 and utilize the estimated process in a non-linear approximation
of the model. For realistic calibrations, an increase in oil price volatility produces a
temporary decrease in durable spending, while precautionary savings motives lead in-
vestment and real GDP to rise. Irreversible capital and durable investment decisions
do not overturn this result.
Clearing Up the Fiscal Multiplier Morass.
Joint with Eric M. Leeper and Todd B. Walker. Bayesian prior predictive analysis of five nested DSGE models suggests that model specifications
and prior distributions tightly circumscribe the range of possible government spending
multipliers. Multipliers are decomposed into wealth and substitution effects, yielding uniform
comparisons across models. By constraining the multiplier to tight ranges, model and prior
selections bias results, revealing less about fiscal effects in data than about the lenses through
which researchers choose to interpret data. When monetary policy actively targets inflation,
output multipliers can exceed one, but investment multipliers are likely to be negative. Passive
monetary policy produces consistently strong multipliers for output, consumption, and investment.
The Implications of Tax Foresight for Optimal Monetary Policy Legislative and implementation lags inherent in the political process often allow private agents to receive news about their future
tax rates, giving agents "tax foresight." This paper investigates the effects of tax foresight on monetary policy under various assumptions about the
information set of the monetary authority. We examine the welfare effects of tax foresight and how such foresight affects the monetary authority's ability to
implement its policy. Our model is a simple version of the dynamic sticky price models extended to include possible foresight about changes in distortionary taxes.
We find that the optimal response of the interest rate to anticipated tax changes can be qualitatively different from the response under a simple Taylor rule and that
welfare rankings under foresight depend crucially on the welfare measure. In addition, identification issues present when the monetary authority has partial information
about the state of the economy make it impossible for the monetary authority to recover the correct structural disturbances from its observable variables. This, in turn,
causes the monetary authority to induce history dependence in endogenous variables and worsen the welfare of private agents.
Selected Works in Progress:
Sovereign Risk and Spillovers: Untangling the Web In Europe