State-Dependent Effects of Fiscal Policy

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We investigate the effects of government spending on U.S. economic activity using a threshold version of a structural vector autoregressive model.

Our empirical findings support state-dependent effects of fiscal policy. In particular, the effects of a government spending shock on out- put are significantly larger and more persistent when the economy has a high degree of underutilized resources than when the economy is close to capacity. This evidence is consistent with an underlying structure of the economy in which insufficient aggregate demand often constrains the level of economic activity.