Discussion of
Forni and Pisani’s
“Expansionary Fiscal Policy and the Trade Balance:
Evidence from a Bayesian DSGE model
for the euro area”
Giancarlo Corsetti
(European University Institute and CEPR)
Banca d’Italia 30 June-1 July, 2009, Rome, Italy
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Pressing questions and recent debates
• Fiscal policy
- Size and sign of the multiplier (under what conditions)?
- Interaction with (conventional and unconventional)
monetary policy
- International spillovers (demand leakages and exchange
rate)? Need for coordination?
• But what is the transmission mechanism? Some recent VAR
results have revived old debates (consumption multiplier)
but also questioned received wisdom on the transmission
- Exchange rates: evidence of depreciation in response to
positive spending shock for the US (and other countries)
- (Interest rate)
- Twin deficits: for the US, evidence is mixed.
What does the paper do
• Drawing on Adolfson et al. (2007) and Coenen et al. (2008)
use Bayesian open economy DSGE model to assess the
quantitative effects of fiscal shocks in the euro area vis-à-vis
a (relatively more closed) foreign region (with no spillovers
from the home region)
• Model is rich on the fiscal side (spending, taxes), and
accounts for financial frictions including ‘hand-to-mouth
• focus on two key dimensions: trade balance and
international prices (real exchange rates)
• Preliminary, yet nice job!
Main results
• Adds to skepticism on fiscal stabilization
- Output multiplier almost never above one
- Investment is crowded out in response to spending and
transfers shocks, although is mildly crowded in by
temporary reduction in taxes
- Consumption multiplier are negative in response to
temporary hikes of spending on final goods and taxes on
final goods; contained if temporary public transfers
- consumption response is strong in response to temporary
reduction in labour and consumption taxes
=> Stress on the need for a sharper understanding of
transmission (more later)
• Specific contribution to debate
- Find twin deficits for spending and transfers
- Terms of trade appreciate in response to shocks to
spending, transfers, capital income taxes (depreciates
with cuts in wage and consumption taxes)
Focus of my comments: Exchange Rates
• I focus on exchange rates. First some evidence. I draw from
ongoing work with Gernot Mueller and Andre Meier.
VAR evidence on the response of Spending shocks (augmented
Blanchard-Perotti) for the US:
More evidence
• VAR evidence on the response of Spending shock for a sample
of OECD countries (annual data)
What is at stake? Theory
Which model predicts a real exchange rate (terms of trade)
depreciation in response to spending shocks?
• Not a new issue: dubbed embarrassing failure of the Mundell
Fleming model, by e.g. Dornbusch 1980
• Should we amend the standard GE models?
- F. Bilbiie; T. Monacelli and R. Perotti (among others)
stress complementarity between consumption and
- M. Ravn, S. Schmidt-Grohe and M. Uribe emphasize ‘deep
habits’ in government consumption.
• Should we rethink the way we model fiscal policy?
- Joint work with A. Meier and G. Mueller: stress on
medium-term fiscal framework (spending reversals)
What is at stake? Empirics
• Is depreciation specific to the US (UK, Canada and Australia,
or to our sample average)?
- Beetsma, Giuliodori and Klaassen report real
appreciation for European countries
- CMM provide some evidence that the transmission of
spending is associated with appreciation under fixed
exchange rates
• Is depreciation a by-product of mis-specification?
- However, depreciation seems to be detected also using
Ramey’s approach to identification
A key question
• Can (estimated) DSGE models like the one in the paper shed
light on the above issues, both theoretically and empirically?
• The model imposes lots of structure on the data. The
question is whether it is given a change to let the data ‘pick
the winner’ among alternative transmission mechanisms
• In the specification proposed in the draft, transmission is
textbook. In response to spending and transfer shocks:
- Consumption by ricardian households is crowded out
- Non-ricardian consume more but not enough to drive
aggregate consumption up
• Why? The standard answer is ‘wealth effects’.
• But note that ricardian consumption rises in response to
temporary cuts in consumption and wage taxes!
A theoretical reconsideration
• In present discount value, the change in the tax burden due
to the assumed temporary increase in spending and transfer
is minuscule (zero in the tax experiments)
• What matters is the change in the intertemporal price of
consumption and investment
• Consumption euler equation: Change in the real return on a
very long-term zero coupon bond
• With ricardian agent and a high degree of risk sharing, for a
given the foreign monetary stance, this is mirrored by the
rate of depreciation
 consumption, long real rate, real exchange rate
• In Figures 2-5 of the paper, appreciation is mirrored by a fall
in ricardians’ consumption
• Interplay between fiscal shocks and asset prices
Spending reversals
Let’s play the same theoretical tune in a different way
• As an empirically promising instance, embed in the model
endogenous dynamic correction of current deficits (actually
in the paper, eqs. 19-21)
- Mix of cuts in spending (below trend) and rise in taxes
(debt sensitivity of spending and taxes)
If current spending shocks are partially reversed over time
• Anticipation of future spending cuts tends to lower future
short real interest rates
• If prices are flexible, current long real rate rises
nonetheless: consumption of ricardian households fall
• With nominal rigidities, under a Taylor rule larger
adjustment in output: current long real rate may fall:
consumption of ricardian households rise
Exogenous spending shocks/or no reversal
Endogenous fiscal policy: reversals
Spending reversals: flex price
Spending reversals: nominal rigidities
Including hand-to-mouth consumers
Taking stocks
• Explore more the issue of endogenous debt correction
• There is empirical evidence on debt sensitivity of spending
(fiscal rule)
• For the US, one can estimate coefficients between -.02 and .03
• The model does pick this up for the euro area. But effect is
swamped by autoregressive coefficient
Matching impulse responses (US)
More to be done (policy and theory)
• Endogenous dynamic of budget (tax and spending) policy
has direct bearing on policy
• Addresses issues raised by zero bound (see Christiano
Eichenbaum and Rebelo; Eggertsson)
• The model could be extended along other lines
- Non separability (Bilbiie, Monacelli-Perotti effects)
- Deep habits
• Report long rates!
Only a word on twin deficit/divergence
• Difficult issue raised by Kim and Roubini. Once again:
- Faulty theory?
- Faulty empirical specification?
• Once again, as is the model is geared towards generating
twin deficits
• Authors have setup a very good framework to address key
issues in the current debate on fiscal policy
• Results so far suggest that textbook model of fiscal
transmission can somehow frame the data for the euro area
- But what is the measure of success?
• Yet the model could do much more --- embed alternative
transmission channels debated by recent literature
• Looking forward to see future versions of it

Concept diagrams available after slide 40