Fiscal Foresight, Limited Information and the Effects of Government Spending Shocks


  • We are indebted to an anonymous referee, Sergio Destefanis, Robert Kunst, Luı's Martins, Giovanni Melina, Lucio Sarno and the participants of the DIW Berlin Macroeconometric Workshop 2011, the 3rd International Conference in memory of Prof. Carlo Giannini at the Banca D'Italia, the 6th Meeting of the Portuguese Economic Journal and the 27th Annual Congress of the European Economic Association/66th European Meeting of the Econometric Society for many helpful comments. Furthermore, we are grateful to Studio Lembo for enduring hospitality. Gasteiger acknowledges financial support from Fundação para a Ciência e a Tecnologia (PEst-OE/EGE/UI0315/2011). All remaining errors are the responsibility of the authors.


We quantify the impact of government spending shocks in the US. Thereby, we control for fiscal foresight, a specific limited information problem (LIP) by utilizing the narrative approach. Moreover, we surmount the generic LIP inherent in vector autoregressions (VARs) by a factor-augmented VAR (FAVAR) approach. We find that a positive deficit-financed defence shock raises output by more than in a VAR (e.g. 2.61 vs. 2.04 for peak multipliers). Furthermore, our evidence suggests that consumption is crowded in. These results are robust to variants of controlling for fiscal foresight and reveal the crucial role of the LIP in fiscal VARs.