The general equilibrium effects of fiscal policy

As a robustness check, we re-estimated the model using the same series detrendedwith an HP filter rather than subtracting linear trends. In line with expectations, weobtain lower estimates for the autoregressive coefficients on the fiscal policy variables.In particular, the autoregressive parameter for government purchases, public employmentand transfers to households drop to, respectively, 0.54, 0.77 and 0.82, while theones on tax rates to 0.86 for labor income taxes, to 0.90 for consumption taxes andto 0.94 for capital income taxes. There are not major differences for the estimates ofthe other parameters (with the notable exception of the habit parameter that dropsfrom 0.84 to 0.72). Notwithstanding these differences, results in terms of impulse responsesare hardly affected. In the following we will present results based only on lineardetrending.As for the fit of the model, we have already showed in figure 3 that the model is ableto replicate the data used for estimation. In figure 5 we report the cross-covariancefunctions of the model variables against the data. We consider four lags and four leads.We plot the 90% confidence bands of the cross-covariance functions obtained on 10,000random samples generated by the DSGE model. The samples are obtained by randomlydrawing 100 times from the parameter posterior distribution and running the model100 times for each parameter draw. Generally, and despite some notable exceptions, asthe cross-covariance between private consumption and investment, the data covariancesfall within the confidence intervals suggesting that the model is able to mimic the crosscovariancein the data within a one year horizon. Most cross-covariances involving fiscalpolicy variables fall within confidence bands.5 General equilibrium effects of fiscal policy5.1 Government spending shocksWe now discuss the implications of our estimates for the effects of government spendingshocks on the economy. Figure 6 shows impulse responses with respect to a shock to realgovernment purchases c g t , figure 7 with respect to a shock to government employment l g t ,while figure 8 with respect to real transfers tr t . The solid line reports median values,while the dotted ones the 5th and 95th percentile based on posterior distributions.The magnitude of the shocks is set in order to have an increase in expenditures equalto one percent of steady state private output (i.e. excluding the government wage23