Fiscal Policies and Credit Regimes: A TVAR Approach∗

This work investigates how the state of credit markets affects the impact of fiscal policies. We estimate a Threshold Vector Autoregression (TVAR) model on U.S quarterly data for the period 1984-2010. We employ the spread between BAA-rated corporate bond yield and 10-year treasury constant maturity rate as a proxy for credit conditions. We find that the response of output to fiscal policy shocks is stronger and more persistent when the economy is in the “tight ” credit regime. Fiscal multipliers are significantly different in the two regimes: they are abundantly and persistently higher than one when firms face increasing financing costs, whereas they are feebler and often lower than one in the “normal ” credit regime. The results appear to be robust to different model specifications, fiscal foresight, alternative threshold variables, different measure of variables and sample periods