Chronicle of a war foretold : the macroeconomic effects of anticipated defense spending shocks

Abstract

We identify news shocks to U.S. defense spending as the shocks that best explain future movements in defense spending over a five-year horizon and are orthogonal to current defense spending. Our identified shocks, though correlated with the Ramey (2011) news shocks, explain a larger share of macroeconomic fluctuations and produce significant demand effects. News about increases in defense spending induces significant and persistent increases in output, hours worked, inflation and the interest rate, and significant increases in investment, consumption and the excess returns of defense contractors on impact.