DP17134 Local Projections in Unstable Environments: How Effective is Fiscal Policy?

Author(s): Atsushi Inoue, Barbara Rossi, Yiru Wang
Publication Date: March 2022
Keyword(s): Fiscal Multiplier, Fiscal policy, government spending, Instability, local projections, monetary policy, Path Estimator, Time variation, Weighted Average Risk
JEL(s): C22, C26, C32, C36, C53
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=17134

The paper develops a local projection estimator for estimating impulse responses in the presence of time variation. Importantly, we allow local instabilities in both slope coefficients and variances. Monte Carlo simulations illustrate that the method performs well in practice. Using our proposed estimator, we shed new light on the effects of fiscal policy shocks and the size of government spending multipliers. Our analysis uncovers the existence of instabilities that were unaccounted for in previous studies, and links time variation in the multipliers to the size of government debt.