Propagation of fiscal and monetary policy shocks

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  • On the 5th of April, Alfan Mansur, will defend his doctoral dissertation “Propagation of fiscal and monetary policy shocks”.

    My dissertation consists of three self-contained articles empirically examining the dynamics of fiscal and monetary policy shocks. Not only do I study the dynamic effects of fiscal and monetary policy shocks, but also the impact of other economic shocks on fiscal and monetary variables. All three articles use the family of Bayesian SVAR models as the analytical tool.

    The first article contributes to the literature on the effects of fiscal and monetary policy by exploiting non-Gaussianity of the time series for the identification of a Bayesian structural vector autoregression model. Using quarterly US data from 1954:IV to 2006:IV and from 1985:I to 2020:III, I formally assess the plausibility of theoretically predicted signs to label fiscal policy, monetary policy, and business cycle shocks. The impulse responses of consumption to the fiscal policy shock depend to some extent on the sample period, but the implied fiscal multiplier is always less than unity. On investment, there is a lagging crowding-out effect with a high probability, but it is not strongly evident in the latter sample. As for the responses after a contractionary monetary policy shock, I find a weakening output after some lags consistent with the leading monetary policy literature. The business cycle shock turns out to matter for government spending only in the long run, while it is already important for the federal funds rate in the short run.

    Similar to the first article, the second article also utilizes non-Gaussianity in identifying structural shocks, but this time it applies to study the impact of fiscal policy and commodity price shocks in a commodity-exporting economy. Using monthly Indonesian data from 2007M1 to 2022M12, I study the impact of a commodity price and three fiscal policy shocks, i.e., fiscal income tax, investment-spending, and consumption-spending shocks. More importantly, I disentangle the commodity-related revenue from the total government revenues. Among the three labeled fiscal policy shocks, I find income tax shock the most impactful on output. Moreover, during the Covid crisis 2020-2021, besides the income tax and consumption-spending shocks, the commodity price shock also positively & substantially contributed to the historical variations in output. I also evaluate the commodity boom period, the tax amnesty program in 2016-2017 and 2022, and the infrastructure spending boost in 2015. The results suggest that output and retail sales would have been lower without the commodity price shock's contribution during the commodity boom period. Then, I find that tax amnesty and infrastructure spending boost policies contribute to higher retail sales.

    In the third article, while existing literature on the classic Mundell-Flemming trilemma model is based on a linearity assumption, this article contributes to it by exploiting the nonlinear dynamics between the elements of the trilemma, particularly the dynamics of capital flow and monetary policy shocks, from a small open economy point of view. The Mundell-Fleming's trilemma underlines tradeoffs among three things: stable exchange rates, independent monetary policy, and free capital mobility. Rey (2015) finds that the global financial cycle has transformed the trilemma into a dilemma that constrains monetary policy independence, regardless of the exchange rate regime. Complementary to the existing literature on this framework, I concentrate on the importance of the volatility regimes of capital flows. I estimate a structural Bayesian threshold vector autoregression (TVAR) on New Zealand quarterly data from 1997:I to 2020:IV. Having allowed for different volatility regimes, I find that the “dilemma” will always bind a small open economy like New Zealand. Not only does the amount of capital flow matter, but its volatility also causes substantial impacts. I also find that a contractionary monetary policy shock lowers capital flow volatility, but hinders real GDP growth in the high volatility regime.

    Alfan Mansur
    Alfan Mansur