Putting Government Spending Shocks under the Microscope: Standard Vector Autoregression versus the Narrative Approach

Standard vector autoregression and the narrative approach yield contrasting responses of consumption and real wages to a government spending shock. A key difference in the approaches is the composition of identified shocks. Standard VAR features a large increase in government purchase of intermediate goods and services and investment, but a small response of government employment compensation. By contrast, the narrative approach identifies a smaller increase in intermediate goods and services purchase but a large increase in employment compensation. Furthermore, empirical evidence indicates impacts of fiscal stimulus vary considerably for different types of spending from the American Recovery and Reinvestment Act.