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The role of fiscal policy in the St. Louis model: Nonparametric estimates for a small open economy

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Abstract

This paper reevaluates the efficacy of monetary and fiscal policies and bidirectional causality between income and each of the policy instruments used in the St. Louis model for aggregate demand using nonparametric (or infinite parametric) spectral methods. We proceed by estimating the strength of the correlations (or partial coherences) between income and each of the policy instruments over various frequencies. Then we obtain the corresponding band regression and Hannan's efficient estimates of both the lead and lag coefficients in the St. Louis model. The analysis is carried out with seasonally adjusted quarterly data and is divided into the flexible, fixed, and managed flexible exchange rate regimes.

We find that while estimates from parametric regressions yield the standard conclusions for the St. Louis model, results from the nonparametric analysis are quite different. Specifically, the results of our analysis reveal that (i) both monetary and fiscal instruments are strongly correlated with income over cycles of 10 quarters or longer for the most recent period of the managed flexible exchange rate regime, and (ii) bidirectional causality exists between income and the fiscal policy instrument. These results suggest that both monetary and fiscal policy have a long-lasting effect on aggregate demand and that bidirectional causality exists between income and policy instruments. An explanation for the existence of bidirectional causality might be that the Canadian government generally pursued a purposeful discretionary fiscal policy during the post-World War II period. Furthermore, it appears that discretionary policy action may have been anticipated by rational, farsighted, and forward-looking economic agents. Finally, our results for the flexible exchange rate and fixed rate regimes are in agreement with the Mundell-Fleming view of the role of monetary fiscal policy in an open economy.

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Authors and Affiliations

  1. School of Business and Economics, Wilfrid Laurier and University, N2L 3C5, Waterloo, Ontario, Canada

    B. Raj & P. L. Siklos

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  1. B. Raj
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  2. P. L. Siklos
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Additional information

The authors are, respectively, Professor and Assistant Professor of Economics. Financial support from the Social Sciences and Humanities Research Council of Canada and the Research Office of Wilfrid Laurier University is gratefully acknowledged. Earlier versions of this paper were presented at the Fourth International Symposium on Forecasting, London, England, July 1984, and at the Economics Department, University of Waterloo, Waterloo, Ontario, Canada, January 1988. The authors are indebted to Stan Winer and William Frazer for helpful comments. Tim Kuehn provided computational assistance.

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Raj, B., Siklos, P.L. The role of fiscal policy in the St. Louis model: Nonparametric estimates for a small open economy. Empirical Economics 13, 169–186 (1988). https://doi.org/10.1007/BF01972447

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