A non-linear analysis of fiscal multipliers and consumption drivers

This thesis explores the non-linear features of fiscal multipliers in the US economy and of consumption drivers in the euro area.
In Chapter 1 we examine a Smooth Transition implementation of a VAR model by Auerbach and Gorodnichenko (2012). We show how the difference in the fiscal multiplier disappears when the design matrix is not augmented with business cycle lags and the model is estimated in first differences. Furthermore, we build on this original approach by using generalized impulse analysis to produce authentic non-linear impulse responses. Our results highlight the Great Recession as a significant turning point, the inclusion of which in the sample enables us to reverse the sign of the effect on GDP of a fiscal shock and endorse the expansionary budget cuts narrative.

Chapter 2 presents the use of the same STVAR and generalized impulse response analysis to examine the non-linear effects of unanticipated government expenditure shocks on US GDP, controlling for private credit and public debt. We also perform a scenario analysis exercise to investigate shock responses during recessions and expansions, while making explicit the effect of the shock on public debt. We find that (i) the results support the inclusion of a measure of fiscal burden in the model; (ii) the GDP response to fiscal shocks is asymmetric in sign and magnitude; (iii) there exists a phenomenon of diminishing returns to expansionary shocks, which limits counter-cyclical fiscal policy; (iv) scenario analysis shows stronger multipliers on average in typical recessions.

We investigate the combined effect of business and financial cycles on a non-linearly fluctuating economy in Chapter 3, designing and estimating a joint economic cycle. A STVAR model and generalized impulse response analysis enable us to examine the non-linear effect on GDP of unanticipated government expenditure shocks, which we complement by performing scenario analysis. The main findings are that (i) every specification shows concordance between signs of shock and GDP response; (ii) the inclusion of an indicator of fiscal capacity in the model leaves the baseline key findings unchanged; (iii) the main results show diminishing returns to increasing expansionary stimuli; (iv) public debt and private credit generally behave pro-cyclically; (v) scenario analysis suggests higher yield to shocks during recessions.

Chapter 4 studies the cyclical dynamics of consumption in the euro area (EA) and the large EA countries by distinguishing between durable and nondurable expenditures. We adopt a theoretical partial equilibrium framework to justify the identification strategy of our empirical model, a time-varying parameter structural vector autoregression (TVP-SVAR). Following the main insight from the theoretical model -- that liquidity constraints induce important interactions between durables and nondurables -- we distinguish durable-specific demand and supply shocks, while taking into account monetary and credit conditions. Our main findings are: (i) durables react faster and more strongly than nondurables after monetary shocks in the euro area and in the largest EA countries; (ii) there is large degree of cross-country heterogeneity in the factors that drive consumption; (iii) strength of spillovers from durables to nondurables is empirically correlated with the likelihood of being liquidity-constrained across countries.