Working Paper

State-Dependent Local Projections: Understanding Impulse Response Heterogeneity

Abstract: An impulse response is the dynamic average effect of an intervention across horizons. We use the well-known Kitagawa-Blinder-Oaxaca decomposition to explore a response’s heterogeneity over time and over states of the economy. This can be implemented with a simple extension to the usual local projection specification that nevertheless keeps the model linear in parameters. Using our new decomposition-based approach, we show how to unpack heterogeneity in the fiscal multiplier, an object that at any point in time may depend on a number of potentially correlated factors, including existing economic conditions and the monetary response. In our application, the fiscal multiplier varies considerably with monetary policy: it can be as small as zero, or as large as 2, depending on the degree of monetary offset.

Keywords: fiscal multipliers; monetary policy; decomposition; local projections; interest rates; fiscal policy; state-dependence; balances;

JEL Classification: C54; C99; E32; E62; H20; H5;

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Bibliographic Information

Provider: Federal Reserve Bank of San Francisco

Part of Series: Working Paper Series

Publication Date: 2023-02-07

Number: 2023-05

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