How big is fiscal policy?: a non-linear analysis for Mexico and the United States

Abstract

Fiscal policy oriented towards increasing government spending has been widely discussed and its not clear whether it stimulates the aggregate demand or not. The effect may vary across the business-cycle, thus this research answers the next question: what is the multiplier effect that public spending has on GDP in periods of recession and expansion? This dissertation defines a period of expansion when the observed GDP is above the potential GDP, and a period of recession when the observed GDP is below the potential GDP. This work estimates the effect of public spending on GDP using non-linear local projections based on Auerbach and Gorodnichenko (2011) using Mexico and the United States as case of study. The results are straightforward: the effect that increasing public spending has on GDP varies across periods of recession and expansion, with a greater positive effect in recessions. In fact, for the Mexican case, increasing public spending has a positive effect in periods of recession and a negative effect in periods of expansion. Whilst, for the United States, in both periods the effect is positive, but bigger in recessions. This work also shows that the relation between government spending and tax collection is quite complicated. For Mexico, increasing government spending leads to an little increase in tax collection in both recessions and expansions. However, for the United States, that is not the case because a positive shock in government spending leads to a decrease in tax revenues.