For U.S. annual data that include WWII, the estimated multiplier for temporary defense spending is 0.4-0.5 contemporaneously and 0.6-0.7 over two years. If the change in defense spending is “permanent” (gauged by Ramey’s defense-news variable), the multipliers are higher by 0.1-0.2. The estimated multipliers are all significantly less than one and apply for given average marginal income-tax rates. We cannot estimate reliable multipliers for non-defense purchases because of the lack of good instruments. Since the defense-spending multipliers are less than one, greater spending crowds out other components of GDP, mainly investment, but also non-defense government purchases and net exports. Consumer expenditure on non-durables and services has only a small response. In a post-1950 sample, increases in average marginal income-tax rates (measured by a newly constructed time series) have significantly negative effects on GDP. When interpreted as a tax multiplier, the magnitude is around 1.1. When we hold constant marginal tax rates, we find no statistically significant effects on GDP from changes in federal tax revenue (using the Romer-Romer exogenous federal tax-revenue change as an instrument). In contrast, with revenue held constant, increases in marginal tax rates still have a statistically significant negative effect on GDP. Therefore, tax changes seem to affect GDP mainly through substitution effects, rather than wealth effects. The combination of the estimated spending and tax multipliers implies that balanced-budget multipliers for defense spending are negative.
We estimate an empirical model of consumption disasters using a new panel data set on consumption for 24 countries and more than 100 years. The model allows for permanent and transitory eects of disasters that unfold over multiple years. It also allows the timing of disasters to be correlated across countries. We estimate the model using Bayesian methods. Our estimates imply that the probability of entering a disaster is 1.7% per year and that disasters last on average for 6.5 years. In the average disaster episode identied by our model, consumption falls by 30% in the short run. In the long run, roughly half of this fall in consumption is reversed. Disasters also greatly increase uncertainty about consumption growth. Our estimates imply a standard deviation of consumption growth during disasters of 12%. We investigate the asset pricing implications of these rare disasters. In a model with power utility and standard values for risk aversion, stocks surge at the onset of a disaster due to agents' strong desire to save. This counterfactual prediction causes a low equity premium, especially in normal times. In contrast, a model with Epstein-Zin-Weil preferences and an intertemporal elasticity of substitution equal to 2 yields a sizeable equity premium in normal times for modest values of risk aversion.