Cyclicality of Fiscal Policy: Permanent and Transitory Shocks

Michel Strawczynski*, Joseph Zeira

*Corresponding author for this work

Research output: Working paper/preprintDiscussion paper


This paper examines the optimal reaction of fiscal policy to permanent and transitory shocks to output in a model of tax and public consumption smoothing. The model predicts that optimal reaction of public expenditures and deficits to transitory shocks should be countercyclical, while optimal reaction to permanent shocks should be a-cyclical. Using the Blanchard and Quah (1989) methodology for identifying permanent and transitory shocks, we test these predictions for a sample of 22 OECD countries over the years 1963-2006. We find that both expenditures and deficits are countercyclical to transitory shocks, mainly through public transfers and mainly in recessions. We find that government investment is pro-cyclical with respect to permanent shocks, but total expenditures are not.
Original languageEnglish
PublisherCERP Discussion Paper
StatePublished - 19 May 2009

Publication series

NameCEPR Discussion Paper


  • Business Fluctuations; Cycles
  • Policy Objectives; Policy Designs and Consistency; Policy Coordination
  • Fiscal Policy


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