IMF Working Papers

Fiscal Foresight and Information Flows

Author/Editor:

Todd B. Walker ; Eric M. Leeper ; Susan S. Yang

Publication Date:

June 1, 2012

Electronic Access:

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Summary:

News - or foresight - about future economic fundamentals can create rational expectations equilibria with non-fundamental representations that pose substantial challenges to econometric efforts to recover the structural shocks to which economic agents react. Using tax policies as a leading example of foresight, simple theory makes transparent the economic behavior and information structures that generate non-fundamental equilibria. Econometric analyses that fail to model foresight will obtain biased estimates of output multipliers for taxes; biases are quantitatively important when two canonical theoretical models are taken as data generating processes. Both the nature of equilibria and the inferences about the effects of anticipated tax changes hinge critically on hypothesized information flows. Different methods for extracting or hypothesizing the information flows are discussed and shown to be alternative techniques for resolving a non-uniqueness problem endemic to moving average representations.

Series:

Working Paper No. 2012/153

Subject:

Econometric analysis Expenditure Financial institutions Fiscal policy Labor taxes Municipal bonds Tax law Tax policy Taxes Vector autoregression