Investigating the E ects of Fiscal Policy in a Time of Crisis: A Dynamic Stochastic General Equilibrium Approach

Julie Madeleine Jø rgensen

Student thesis: Master thesis

Abstract

This thesis analyses the change in the impact of a government spending increase on the economy from 1985-1999 to 2000-2014. The rst time period is characterised by a high degree of economic stability, whereas the latter is characterised by a period of a severe crisis and a large economic downturn. The essential part of this thesis is therefore to investigate whether a time period characterised by recession and economic downturn has altered the response of output, wages, consumption, and investment to a government spending increase. Further, the thesis investigates what mechanisms may have altered this response. In other words, it investigates how the channels of scal policy transmission changed from the rst to the latter time period. The analysis is conducted on the basis of both an empirical Structural Vector Autoregressive model and a theoretical Dynamic Stochastic General Equilibrium model. As the theoretical model allows for a much richer analysis with respect to underlying dynamics than aggregated data, by matching these two models' responses to a government spending shock it allows for the theoretical model to capture the dynamics observed in the data and thereby an in-depth analysis of key mechanisms in the economy. The analysis of the two models shows that the response of the economy to a government spending increase was altered between the two time periods speci ed. In fact output, private consumption, wages and private investment all show more positive responses in the second time period speci ed. This indicates that there is a larger role for government spending in a time impacted by crisis than in a more stable time period. In the analysis it is found that especially an increase in the commitment of an increase in government spending results in a more positive response of the key macroeconomic variables. Further, an increase in the share of consumers, who do not participate in asset markets also seem to have an impact on the responses, together with a higher degree of exibility in wage adjustments and a higher stickiness in price adjustments. The results here thus indicate that there is a larger role for government spending in a time of crisis, especially when there is a larger commitment from the government to increase spending and consumers are credit-constrained. Yet, the numerical value of the responses are still below unity for all the macroeconomic variables, indicating that government spending has less than a one-to-one impact on the economy.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2016
Number of pages149