Do expectations matter? Reassessing the effects of government spending on key macroeconomic variables in Germany

ABSTRACT

This article contributes to the debate on how to properly identify exogenous fiscal shocks in the data. We include expectations held by consumers and firms into the standard vector autoregression (VAR) framework based on information from historical issues of the German political magazine Der Spiegel. The findings underscore the need to account for expectations, as failing to do so leads to significant misinterpretation of the effects of government spending. When neglecting anticipation effects, our results support the recent findings for Germany by pointing to a rather positive effect of government spending on GDP. However, inclusion of expectations yields a change in this effect, suggesting that government spending is much less beneficial for GDP, as it crowds out private consumption and investment.

KEYWORDS:

• Expectations
• fiscal policy
• government spending
• vector autoregression model

JEL CLASSIFICATION:

• C32
• D84
• E32
• E62

Disclosure statement

No potential conflict of interest was reported by the authors.

Supplemental material

The supplemental material for this article can be accessed here.