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In this paper we show that empirically plausible results on the effects of fiscal shocks in Galí, López-Salido and Vallés (2007) rely on a high degree of price stickiness and a large percentage of financially constrained agents. Real rigidities in the form of habit persistence, fixed firm-specific capital and Kimball demand curves interact in interesting ways with nominal and financial rigidities and allow us to reproduce the same consumption multiplier as Galí et al. (2007) under only two and a half quarters of price stickiness, instead of four, and only 30 per cent of constrained agents instead of 50 per cent. Therefore, real rigidities are useful in the study of fiscal shocks in addition to monetary and productivity shocks as has been shown in the previous literature.

Cover -- TABLE OF CONTENTS -- ABSTRACT -- I. INTRODUCTION -- II. DATA AND EMPIRICAL METHODOLOGY -- A. Data -- B. Empirical Framework -- III. EMPIRICAL RESULTS -- A. Baseline -- B. Robustness Checks -- IV. CONCLUSIONS AND POLICY IMPLICATIONS -- REFERENCES -- TABLES -- Table 1. Example: Identification of Reform Episodes -- Table 2: Effect of Tax Reforms on Fiscal Shock Smoothing -- FIGURES -- 1. Direct Tax Reform Indicators Over Time -- 2. Indirect Tax Reform Indicators Over Time -- 3. Effect of Direct Tax Reforms on Fiscal Shock Smoothing -- 4. Effect of PIT Reforms on Fiscal Shock Smoothing -- 5. Effect of CIT Reforms on Fiscal Shock Smoothing -- 6. Effect of Indirect Tax Reforms on Fiscal Shock Smoothing -- 7. Effect of Direct Tax Reforms on Fiscal Shock Smoothing Depending on the Direction of the Reform -- 8. Effect of Indirect Tax Rate Reforms on Fiscal Shock Smoothing Depending on the Direction of the Reform -- 9. Effect of Direct Tax Reforms on Tax Elasticity with Respect to Output -- 10. Effect of Indirect Tax Reforms on Tax Elasticity with Respect to Output -- 11. Effect of PIT Reforms on Tax Progressivity -- 12. Effect of VAT Reforms on C-Efficiency -- 13. Effect of Direct Tax Reforms on Fiscal Shock Smoothing Controlling for the Initial Level of Public Debt -- 14. IV Estimator: Effect of PIT Reforms on Tax Progressivity -- 15. GMM Estimator: Effect of Direct Tax Reforms on Fiscal Shock Smoothing -- 16. Alternative Reform Threshold: Effect of Tax Reforms on Fiscal Shock Smoothing -- 17. Alternative Reform Codification: Effect of Tax Reforms on Fiscal Shock Smoothing -- 18. Alternative Database: Effect of Tax Reforms on Fiscal Shock Smoothing -- APPENDICES -- Table A1. OECD: Distribution of Tax Policy Changes in the TPRD Database -- Table A2. 13 OECD Countries: Summary Statistics - Exogenous Database.

Cover -- Contents -- Abstract -- I. Introduction -- II. Modeling Framework -- III. Empirical Approach and Data -- A. Identification of fiscal shocks -- B. Econometric specification -- C. Data -- IV. Empirical Results -- A. Baseline results -- B. Spillovers in Normal Times and near the ELB -- V. Robustness -- A. Alternative definition of the ELB -- B. Alternative shock identification -- VI. Conclusions -- VII. References -- VIII. Appendix -- A. Data -- Data for shock identification -- Data for spillover analysis -- B. Fiscal shock identification -- VAR specification -- Identification -- C. Robustness to inclusion of additional control variables

PurposeThis study analyses the impact of fiscal shocks on GDP, inflation and interest rates in Portugal over 1995–2017.Design/methodology/approachMultipliers are estimated using a structural VAR (SVAR) a' la Blanchard and Perotti (2002) using OECD elasticities. Changes in direct and indirect taxes are considered for fiscal shocks on the revenue side and changes in public consumption, investment and transfers for fiscal shocks on the expenditure side.FindingsThe analysis finds small tax multipliers and larger government consumption multipliers for growth, while short-term responses to shocks in transfer and investment spending are found to be negligible. Fiscal shocks have an ambiguous impact on inflation, and fiscal shocks of an expansionary nature are found to trigger declines in interest rates. The results are robust to different orderings of variables, to the selection of an alternative time period which excludes the financial crisis and to an alternative estimation technique.Research limitations/implicationsA major limitation of the study relates to the relatively short time period which does not allow capturing the impact of possible structural breaks.Practical implicationsThis analysis is relevant for countries, like Portugal, that display high debt levels and volatile market sentiment and lack an independent monetary policy.Originality/valueOverall, the analysis of output multipliers compares well with some other studies conducted on the Portuguese economy and confirms the importance of the disposable income channel in the transmission of fiscal shocks to the rest of the economy. The study is one of the first to focus also on the implications of fiscal shocks on inflation and long-term interest rates. It is the first to apply the local projection method to estimate multipliers in Portugal.

Although theoretical models consistently predict that government spending shocks should lead to appreciation of the domestic currency, empirical studies have regularly found depreciation. Using daily data on U.S. defense spending (announced and actual payments), the paper documents that the dollar immediately and strongly appreciates after announcements about future government spending. In contrast, actual payments lead to no discernible effect on the exchange rate. It examines the responses of other variables at the daily frequency and explores how the response of the exchange rate to fiscal shocks varies over the business cycle as well as at the zero lower bound and in normal times.

Although theoretical models consistently predict that government spending shocks should lead to appreciation of the domestic currency, empirical studies have regularly found depreciation. Using daily data on U.S. defense spending (announced and actual payments), the paper documents that the dollar immediately and strongly appreciates after announcements about future government spending. In contrast, actual payments lead to no discernible effect on the exchange rate. It examines the responses of other variables at the daily frequency and explores how the response of the exchange rate to fiscal shocks varies over the business cycle as well as at the zero lower bound and in normal times.

Although theoretical models consistently predict that government spending shocks should lead to appreciation of the domestic currency, empirical studies have regularly found depreciation. Using daily data on U.S. defense spending (announced and actual payments), the paper documents that the dollar immediately and strongly appreciates after announcements about future government spending. In contrast, actual payments lead to no discernible effect on the exchange rate. It examines the responses of other variables at the daily frequency and explores how the response of the exchange rate to fiscal shocks varies over the business cycle as well as at the zero lower bound and in normal times.