This paper estimates the impact of government spending shocks on economic activity during periods of high and low uncertainty and during periods of boom and recession. We find that government spending shocks have larger impacts on output in booms than in recessions and larger impacts during tranquil times than during uncertain times. The results suggest that confidence plays an important role in explaining this differential impact.

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We provide evidence that many narrative shocks used by prominent literature are persistent. We show that the two leading methods to estimate impulse responses to an independently identified shock (local projections and distributed lag models) treat persistence differently, hence identifying different objects. We propose corrections to re-establish the equivalence between local projections and distributed lag models, providing applied researchers with methods and guidance to estimate their desired object of interest. We apply these methods to well-known empirical work and find that how persistence is treated has a sizable impact on the estimates of dynamic effects.

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The last review of the ECB's monetary policy strategy in 2003 followed a period of predominantly upside risks to price stability. Experience following the 2008 financial crisis has focused renewed attention on the question of how monetary and fiscal policy should best interact, in particular in an environment of structurally low interest rates and persistent downside risks to price stability. This debate has been further intensified by the economic impact of the coronavirus (COVID-19) pandemic. In the euro area, the unique architecture of a monetary union consisting of sovereign Member States, with cross-country heterogeneities and weaknesses in its overall construction, poses important challenges.12 Tax policy may also substitute interest rate policy to change real interest rates (the cost of current consumption in terms of future consumption), even in the case of balanced budgets. See Feldstein (2002) and Correia et al. (2013).