Working Paper

Assessing the effects of fiscal shocks

Abstract: This paper investigates the response of real wages and hours worked to an exogenous shock in fiscal policy. We identify this shock with the dynamic response of government purchases and tax rates to an exogenous increase in military purchases. The fiscal shocks that we isolate are characterized by highly correlated increases in government purchases, tax rates and hours worked as well as persistent declines in real wages. We assess the ability of standard Real business Cycle models to account for these facts. They can-but only under the assumption that marginal income tax rates are constant, a standard assumption in the literature. Once we abandon this counterfactual assumption, RBC models cannot account for the facts. We argue that our empirical findings pose a challenge to a wide class of business cycle models.

Keywords: Hours of labor; Business cycles; Fiscal policy;

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    Burnside, Craig

    Fisher, Jonas D. M.

    Eichenbaum, Martin

Bibliographic Information

Provider: Federal Reserve Bank of Chicago

Part of Series: Working Paper Series

Publication Date: 1999

Number: WP-99-18