Vector autoregression analysis of the dynamic effects of fiscal policy shocks: An application in Turkey

The effects of fiscal policy on economic activity are still debated both theoretically and empirically. Theoretical discussions have been carried on through macroeconomic models developed by different schools of thought. The question whether fiscal policy stimulate economic activity through aggregate demand is focal point of the discussion in non-micro founded macroeconomic models. On the other hand the discussions surrounding micro founded macroeconomic models are focused on the effects of fiscal policy on consumption, employment and real wage. Empiric literature related with fiscal policy is mostly based on Vector Autoregression (VAR) methodology. There are four approaches developed in order to observe the effects of fiscal policy shocks in VAR literature. Each of these approaches puts forward different solutions to identify fiscal policy shocks. In this study, the effects of fiscal policy shocks on Turkish economy are analyzed by VAR technique and sign restriction approach for 1988:1-2010:4 periods. The findings of the study show that the most effective policy strategies to stimulate economic activity is deficit financed tax cut. The other policy strategies based on an increase in government spending cause crowding-out in consumption and investment. In light of these findings the fiscal policy to stimulate economic activity in Turkey should be based on tax cuts. Furthermore, the effects of an increase in government spending depend on financing method. Consequently, an increase in government spending in Turkey should be financed by budget deficit instead of tax increasing.