Chronicle of a war foretold : the macroeconomic effects of anticipated defence spending shocks

Abstract

We identify US defense news shocks as shocks that best explain future moviments in defense spending over a five-year horizon and are orthogonal to current defense spending. Our identified shocks are strongly correlated with the Ramey (2011) news shocks, but explain a larger share of macroeconomic fluctuations and have significant demand effects. Fiscal news induces significant and persistent increases in output, consumption, investment, hours and the interest rate. Standard DSGE models fail to produce such a pattern. We propose a sticky price model with variable capital utilization, capital adjustment costs, and rule-of-thumb consumers that replicates the empirical findings and allows us to test the validity of our methodology for extracting anticipated fiscal shocks from the data.