DP12335 Tax shocks with high and low uncertainty

Author(s): Fabio Bertolotti, Massimiliano Marcellino
Publication Date: September 2017
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Programme Areas: Monetary Economics and Fluctuations
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=12335

We assess whether the effects of fiscal policy depend on the extent of uncertainty in the economy. Specifically, focusing on tax shocks, identified by the narrative series by Romer and Romer (2010), and various measures of uncertainty, we use a Threshold VAR model to allow for dependence of the effects of the tax shocks both on the level of uncertainty and on the sign of the shock. Our two main empirical results are that the economy responds more positively to tax cuts during periods of low uncertainty, while, in response to tax increases, monetary policy contributes significantly in making the reaction of the economy neutral during more uncertain times. We also show that existing theoretical models can explain, to a good extent, this empirical evidence.