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Identifying Government Spending Shocks: It~s All In The Timing

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Executive Summary

Do shocks to government spending raise or lower consumption and real wages? Standard VAR identification approaches show a rise in these variables, whereas the Ramey-Shapiro narrative identification approach finds a fall. The author shows that a key difference in the approaches is the timing. Both professional forecasts and the narrative approach shocks Granger-cause the VAR shocks, implying that the VAR shocks are missing the timing of the news. Simulations from a standard neoclassical model in which government spending is anticipated by several quarters demonstrate that VARs estimated with faulty timing can produce a rise in consumption even when it decreases in the model.

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