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Prepared by Helge Berger and Louis Kuijs.
A multiplier in “dollar-for dollar terms” measures the ratio of the (absolute) amount of additional activity in terms of currency units generated by one unit of additional expenditure.
In the absence of liquidity constraints, temporary tax cuts that are later reversed would not have any effect on spending.
The available quarterly fiscal data accounts for 34 percent of expenditures, and data on revenues that accounts for 84 percent of the total.
Sometimes et is referred to as the vector of unexpected movements or surprises based on the reduced-form VAR model.
See CH for comparable results for Finland. The empirical section below comments on the robustness of these assumptions.
The assumption is in line with preliminary estimates of (3) which found no robust evidence that either a2 or b2 is statistically and economically significant.
To help the model capture some of the exogenous structural changes influencing GDP growth during the 1990s—that is, the breakdown of Finland's trade relations with the former Soviet Union, the banking crisis in the early 1990s, and the rise of the export-driving ICT sector—both a linear time and a non-linear time trend are included. The latter is a Hodrick-Prescott approximation of actual GDP growth with the smoothing factor set to 1,000.
The (log-) estimates of the coefficients are transformed into dollar-for-dollar based on sample means of the revenue-to-GDP and expenditure-to-GDP ratios, respectively. The dynamic results discussed below are treated equivalently.
Comparisons with BP are based on their model assuming a deterministic trend in the VAR (as in our model). The data definition used by BP differs from ours, but comparable results following their specifications can be obtained. All CH results have been transformed into dollar-for-dollar terms assuming a revenue-to-GDP and expenditure-to-GDP ratio of 0.45.
The comparison for Spain is less straightforward, since CH present nonstandardized impulse responses. However, based on the time profile of the GDP reaction to the tax shock and the high contemporaneous impact described above, the dynamic effect would clearly appear to exceed the one reported in Figure 3.
There are some indications that the longer-term impact of tax changes in Finland (as well as in other Nordic economies) could be somewhat weaker than in other countries (Daveri and Tabellini, 2000). Koskela and Uusitalo (2003) argue this could be due to the more centralized bargaining systems in the Nordic region which might make wage formation less sensitive to changes in taxation compared to less centralized systems. The explanation is not fully compelling, however. In the Finnish case, for example, the government has used the centralized wage negotiations of recent years to condition tax policy on wage behavior, fostering wage moderation through promises of tax cuts on labor.