Assessing the effects of fiscal policy news under imperfect information

Abstract

Abstract We study the transmission of fiscal policy under imperfect information where government spending is composed of permanent and transitory components. Agents learn about the previous processes by only observing overall public spending and a noisy signal. Under this theoretical setting, we construct a novel measure of fiscal policy news and show that the estimated variable agrees with the historical narrative evidence for the US economy. Our measure captures sluggish information shocks rather than revisions with the benefit of being generated by a theoretical model. We then document the effects of this proxy on economic activity by using local projection methods. The results indicate that real activity indicators exhibit delayed positive effects. We also notice that public debt shrinks and tax revenues increase after 2 years due to the delayed output expansion in the aftermath of the fiscal news shock.