Current US fiscal policy is absolutely frustrating. There does seem to be a clear direction, in particular because policy making is rather irrational due to a set of unduly influential and crazy lawmakers. In the end, this means considerable uncertainty about future fiscal policy, in particular because it may not react to economic events in ways that make economic or historic sense. What is the impact of such uncertainty?
Jesús Fernández-Villaverde, Pablo Guerrón-Quintana, Keith Kuester and Juan Rubio-Ramirez address this with a New Keynesian business cycle model that feature variable volatility in fiscal policy. Their conclusion is that the current uncertainty lowers activity and has the policy equivalent of a 25 basis point increase in the federal funds rate, which I find rather minor. The model rightfully yields that the main mechanism is through investment and the uncertainty on capital return taxation. I find it interesting that it leads to stagflation, as firm opt for higher prices to reduce miss-pricing costs. In the end, the authors show that if one removes the usual automatic stabilizers and assume very persistent fiscal shocks, which may be a good characterization of the current situation, the prediction is a 0.5% reduction in output, which I am ready to believe.