Ramifications of fiscal shocks in a globalised world
The impact of fiscal policy on exchange rates is of key interest to policymakers. This column argues that unexpected government spending instantly affects exchange rates. The finding, predicated on daily data reporting of the united states Defence Department, may claim that unexpected government spending has broader macroeconomic effects aswell. The results, however, usually do not hold is low-frequency data are used instead.
What are the consequences of fiscal policy on aggregate economic activity in a globalised world? That is an integral question in current policy and academic debates.
The central challenge in this debate is how exactly to identify fiscal shocks in the info. Previous research (e.g., Blanchard and Perotti 2002, Romer and Romer 2010) has used structural or narrative time series solutions to isolate unanticipated, exogenous innovations to government spending or revenue.
While these approaches have many desirable properties, they routinely have been applied at quarterly as well as annual frequencies. These low frequencies can limit the plausibility of identifying assumptions (e.g., minimum delay restriction for government spending) and reduce statistical power (e.g., narrative shocks can take into account just a few historical changes in fiscal variables).
New evidence using daily data on government spending
In recent work, we address this challenge through the use of daily data on US government spending (Auerbach and Gorodnichenko 2015). Using daily variation does limit the scope of our investigation, for we cannot measure the ramifications of shocks on slow moving aggregate variables, like real GDP, that comparable high-frequency data are unavailable. However, high-frequency analysis greatly enhances our capability to assess reactions of forward-looking variables such as for example exchange rates, asset prices, yields, etc.
In previous research, analyses of how these variables respond to government spending or revenue shocks were limited since it was hard to eliminate reverse causality using low-frequency data. On the other hand, you can be fairly sure that, on confirmed day, shocks to actual or contracted payments of the government are not suffering from economic news and therefore causation will probably flow from fiscal variables to forward-looking variables.
Inside our research, we’ve constructed two daily series for government defence spending. The first series is payments to defence contractors reported in the daily statements of the united states Treasury. The next series may be the announced level of contracts awarded daily by the united states Department of Defence. Since one series measures actual outlays as the other provides a way of measuring future government spending, using both of these series helps us to underscore the main element role of fiscal foresight for timing shocks to government spending and also responses to these shocks. Although it is possible to create more government spending variables at the daily frequency, we concentrate on military spending to minimise the chance of reserve causality and other styles of endogeneity, and because defence procurement is this important section of the federal budget and a significant source of volatility for the reason that budget.
While interpretation of spending shocks as of this high frequency could be complex – we discuss these shocks can include ‘level’ (just how much to invest), ‘timing’ (when to invest), and ‘identity’ (who receives government funding) components – we document that one shocks to government spending have a non-negligible ‘level’ component, which may be the component typically studied with data at quarterly or annual frequencies. Specifically, we show that announcements about future military spending move the index of stock charges for firms in the defence industry.
Department of Defence contracts
Since 1994, just about any weekday at 5 pm, the Department of Defence has announced (on http://www.defense.gov/contracts/) its new contract awards higher than $6.5 million. An average announcement specifies the duration of the contract, the awarded amount, the name of the winner, the positioning of contract execution, and extra details about the type of the contract. Each contract is assigned a distinctive code and is summarised by a paragraph within an announcement. The contracts have a tendency to be of multi-year duration. The Department also makes announcements about modifications to existing contracts. In order to avoid mixing anticipated and unanticipated awards, we only use announcements of new contracts, that’s, contracts that appear for the very first time on the Department of Defence’s website.
One drawback of using these data is that the Department will not provide them in a format ideal for statistical analysis. To convert these details into usable form, we’ve downloaded webpages with announcements from the Department’s archive and parsed data from the net pages. To verify the caliber of the info, we use several algorithms of parsing information from the written text of announcements, have at least two different people check the consistency of collected data, and randomly check the validity of information extracted from an example of webpages by independent research assistants. Overall, the caliber of the data is apparently high.
As the announcements aren’t immediately translated into actual disbursements, using announcements offers one key potential advantage. Standard theory predicts that unconstrained, forward-looking agents should react during the news instead of when actual spending occurs. The announcements can thus give a better timing for spending shocks, as measured by today’s value of contract awards.
Our group of daily totals of announced contracts shows huge variation (Panel A, Figure 1). The awarded amounts change from $3 million to almost $25 billion with a typical deviation of $1.2 billion and a mean of $450 million. In keeping with the view these announcements usually do not simply reflect high-frequency timing, daily contract awards usually do not appear much smoother when aggregated to monthly frequency (Panel B, Figure 1). Enough time group of monthly totals of awarded contracts is characterised by low serial correlation and spikes without the discernible seasonal pattern. Furthermore, these spikes in monthly totals could be linked to major military developments. For instance, we observe a surge in awarded contracts soon after the 9/11 terrorist attack, the beginning of the next Iraq war in 2003, the Russo-Georgian war in 2008, and the beginning of Operation New Dawn. On the other hand, we observe no significant movements in actual payments on defence contracts, the other series found in our analysis.
Figure 1 . New contracts awarded by the Department of Defence (in huge amount of money)
Panel A. Daily totals
Panel B. Monthly totals
We follow our earlier work (Auerbach and Gorodnichenko 2012, 2013) and estimate the result of government spending using direct projections as in Jorda (2005). Specifically, we construct impulse responses by running a number of regressions (start to see the paper for details). As inside our earlier work, we extend the direct-projections method of allow the responses to alter by the state of the economy, for instance, where regimes match recessions and expansions. Furthermore, given the amount of observations offered by a daily frequency, it really is feasible to increase the method of estimation based on a far more sophisticated classifications of regimes, such as for example recession with a binding zero lower bound (ZLB) on short-term nominal interest levels.
Panel A of Figure 2 shows the impulse response of the nominal exchange rate (the Trade Weighted US Dollar Index, Major Currencies) to a unit shock in the Department of Defence’s announcements (daily log level of awarded contracts, de-seasonalised and de-trended). During the shock, the dollar appreciates by 0.0001 (that’s, 0.01%). This contemporaneous response is statistically significant at the 95% level. As time passes, the exchange rate appreciates further and reaches the utmost appreciation of 0.00052 after about 25 business days. Given how much volatility in both series (the exchange rate and the Department’s announcements), statistical need for the idea estimates is remarkable.
The direction of the response of the exchange rate is in keeping with basic macroeconomic theory; within an economy with a flexible exchange rate, government spending shocks should result in appreciation of the domestic currency. The dynamics of the appreciation are broadly consistent with economic theory aswell. As the exchange rate peaks with a delay, the duration of the delay is rather short in accordance with previous studies where in fact the maximum reaction was delayed by many months. Interestingly, whenever we aggregate data to the monthly frequency, the delay becomes more pronounced – the response peaks after half a year.
Therefore, the delayed responses in the last literature may be partly due to the usage of low-frequency data.
To contrast the difference between announced and actual spending, we present the daily response of the exchange rate to actual spending (daily payments to defence contractors) in Panel B of Figure 2. We find no significant response at any horizon. The pattern is comparable whenever we estimate the response using data at the monthly frequency; if anything, the idea estimates claim that the dollar depreciates.
This difference in responses to actual and announced government spending shocks can explain why previous studies using actual spending and data at low frequencies didn’t look for a robust link between exchange rate movements and fundamentals like the fiscal deficit.
Figure 2 . Impulse responses to a government spending shock, daily data.
Panel A. Department of Defence announcements
Panel B. Daily payments to defence contractors
Auerbach, A, and Y Gorodnichenko (2012), "Fiscal Multipliers in Recession and Expansion," in Fiscal Policy following the FINANCIAL MELTDOWN, A Alesina and F Giavazzi, eds., University of Chicago Press.
Auerbach, A, and Y Gorodnichenko (2013), "Output Spillovers from Fiscal Policy," American Economic Review Papers and Proceedings 103,141-146.
Auerbach, A, and Y Gorodnichenko (2015), "Ramifications of Fiscal Shocks in a Globalized World," NBER WP 21100.
Blanchard, O, and R Perotti (2002), “An Empirical Characterization of the Dynamic Ramifications of Changes in Government Spending and Taxes on Output,” Quarterly Journal of Economics 117(4), 1329-1368.
Jorda, O (2005), “Estimation and Inference of Impulse Responses by Local Projections,” The American Economic Review 95(1), 161-182.