3 Effects of fiscal policy
This section replicates Blanchard and Perotti’s (2002) deterministic and stochastic trend models using New Zealand data. It first examines the instantaneous (contemporaneous) effects of government spending and net tax shocks and then assesses the dynamic effects using impulse response analysis.
3.1 Contemporaneous effects
Table 1 reports the estimated coefficients of the relationships between shocks shown in equations (2) to (4) for both the deterministic and stochastic specifications. Although the parameters α2, b2, c1 and c2 are elasticities, to aid interpretation, the point estimates in Table 1 have been transformed to derivatives evaluated at their means and, therefore, can be interpreted as the constant dollar change in one variable per constant dollar in another.
| α2 | b2 | c1 | c2 | |
|---|---|---|---|---|
| Deterministic specification | ||||
| Coefficient | -0.16 | -0.06 | -0.25 | 0.14 |
| t-statistic | -0.88 | -0.87 | -2.23 | 0.76 |
| Stochastic specification | ||||
| Coefficient | -0.12 | -0.05 | -0.25 | 0.13 |
| t-statistic | -0.68 | -0.68 | -2.27 | 0.70 |
The direction of the contemporaneous impact of GDP from both the net tax and government spending shocks are consistent with the predictions of a simple neo-Keynesian model, with limited price flexibility in the short-run. Both the deterministic and stochastic specifications show that the contemporaneous effect of a net tax shock on GDP (c1) is negative, while the contemporaneous effect of a government spending shock on GDP (c2) is positive. These estimates also suggest the initial absolute impact of an increase in net tax on GDP is larger than an equivalent increase in government spending.
For the deterministic specification, a one dollar increase in net tax immediately reduces GDP by 0.25 dollars. For the stochastic specification, the immediate impact is equal -- with a one dollar increase in net tax also reducing GDP by 0.25 dollars in the first quarter.
For a government spending shock, the contemporaneous impact on GDP is also almost the same for the deterministic specification and the stochastic specification. The estimate for c2 under the deterministic specification shows an increase in government spending by one dollar results in an immediate increase in GDP of 0.14 dollars. For the stochastic specification, the increase in GDP is 0.13 dollars. Note that point estimates for c1 are statistically significant from zero at the 5 percent significance level. This is not the case for c2.
Table 1 also suggests the issue of whether net tax or government spending are ordered first is inconsequential. Because the correlation between cyclically adjusted net tax and government spending shocks is low, the point estimates for α2 (i.e. when net tax are ordered first) and b2 (i.e. when government spending is ordered first) are close to zero. This result is confirmed in the sensitivity analysis in section 4.
