DP12541 The Combination of Monetary and Fiscal Policy Shocks: A TVP-FAVAR Approach

Author(s): Francesco Molteni, Evi Pappa
Publication Date: December 2017
Keyword(s): fiscal policy shocks, monetary policy shocks, narrative evidence, TVP-FAVAR
JEL(s): C32, E52, E62, E63, E65
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12541

We analyze the joint effects of monetary and fiscal policy shocks in the U.S. economy using a factor augmented vector autoregressive model with drifting coefficients and stochastic volatility. The time varying structure of the model allows us to assess whether the transmission of monetary policy shocks differ when combined with exogenous expansionary and contractionary fiscal shocks, identified with the narrative approach. Government spending and temporary fiscal transfers weaken the effects of monetary policy shocks; permanent transfers are less effective to counteract the demand effects of monetary policy changes; while tax shocks do not alter the propagation of monetary policy shocks.