The time-varying effect of fiscal policy on inflation: Evidence from historical US data

We estimate vector autoregressions with time-varying parameters to demonstrate that the impulse response of inflation to government spending shocks underwent significant changes over time. Fiscal spending increases lowered inflation in the first half of the postwar period, but have been inflationary...

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Bibliographic Details
Published in:Economics letters 2020-01, Vol.186, p.108823, Article 108823
Main Authors: Klein, Mathias, Linnemann, Ludger
Format: Article
Language:English
Subjects:
Fiscal policy
Government spending
Inflation
Keynesian theory
Regression analysis
Time-varying parameters
Vector autoregression
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Summary:We estimate vector autoregressions with time-varying parameters to demonstrate that the impulse response of inflation to government spending shocks underwent significant changes over time. Fiscal spending increases lowered inflation in the first half of the postwar period, but have been inflationary from about 1980 onwards. In contrast to estimates based on models with constant parameters, the evidence for more recent decades is in line with the prediction of basic New Keynesian models. •We use time-varying VARs to estimate the effect of US fiscal policy on inflation.•Inflation responded negatively in the past, but positively after about 1980.•The most recent evidence is in line with the prediction of New Keynesian models.
ISSN:0165-1765
1873-7374
DOI:10.1016/j.econlet.2019.108823