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Fiscal Developments And Financial Stress: A Threshold VAR Analysis

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Executive Summary

The authors use a threshold VAR analysis to study whether the effects of fiscal policy on economic activity differ depending on financial market conditions. In particular, they investigate the possibility of a non-linear propagation of fiscal developments according to different financial market stress regimes. More specifically they employ a quarterly dataset, for the U.S., the U.K., Germany and Italy, for the period 1980:4-2009:4, encompassing macro, fiscal and financial variables. The results show that the use of a nonlinear framework with regime switches is corroborated by nonlinearity tests; the responses of economic growth to a fiscal shock are mostly positive in both financial stress regimes.

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