The time-varying effect of fiscal policy on inflation: Evidence from historical US data

Abstract We estimate vector autoregressions with time-varying parameters to demonstrate that the impulse response of inflation to government spending shocks underwent significant changes over time. Fiscal spending increases lowered inflation in the first half of the postwar period, but have been inflationary from about 1980 onwards. In contrast to estimates based on models with constant parameters, the evidence for more recent decades is in line with the prediction of basic New Keynesian models.