Fiscal Policies Are Not All Alike: Composition Effects, Regime Switching and Uncertainty

This paper examines the effects of fiscal policy on GDP, accounting for its composition and the prevailing policy regime (fiscal or monetary dominance). Using U.S. data, we estimate a Markov-switching Taylor rule to identify time-varying regimes and assess the dynamic effects of fiscal shocks—distinguishing between public consumption and investment—through nonlinear local projections. Our results show that under fiscal dominance fiscal shocks bring about larger and more persistent output responses. A DSGE model with regime shifts rationalizes these findings, showing that public consumption mainly boosts demand, while public investment enhances productivity through capital accumulation. The difference between the two components is particularly pronounced under monetary dominance, where monetary tightening dampens the demand-driven impact of consumption but not the supply-side gains from investment. Finally, we show empirically that policy uncertainty modulates these effects: government consumption is more stimulative in low-uncertainty environments, whereas government investment seems not to depend strongly on the uncertainty scenarios.