Is Government Spending Shock More Effective in Financial Boom or During Recessions?

The primary objective of the present article is to study the impact of positive and negative shocks in government expenditures during different financial cycles on economic variables in Iran. The relationship between the financial sector and the real sector of the economy will cause the importance of financial markets. To this end, first, the financial condition index was created through principal components analysis. Then, using the LR non-linear test and the data related to the period of 2005 to 2019, while studying non-linearity among variables relationship, the threshold value variable was estimated exogenously. Therefore, the value of the threshold of the financial index is considered to be -0.36. Seasons lower than the threshold variable indicate the period of recession and higher than the threshold variable indicate the period of financial prosperity. Threshold vector Autoregression Model (TVAR) with the assumption of the possibility of regime switching and generalized impulse-response functions are extracted to examine the impact of positive and negative shocks government expenditures. Based on the results, the reaction of economic variables to positive shocks in government expenditures will be independent of the financial cycle whereas the reaction to negative shocks in government expenditures is influenced by the financial cycle, especially during the period of recession.