Episodes of war and peace in an estimated open economy model

Abstract

This paper proposes a straight model-based analysis of historical war episodes. We analyze the effects of world wars on the macroeconomic dynamics in the US, France, Germany, and the UK, by means of an estimated open-economy model where war episodes are modeled as an additional source of observed shocks. The model allows war episodes to affect the economy through lower capital depreciation, partial default on public debt, a military draft, changes in household preferences, and spillovers on other shocks (productivity, investment, trade, policy variables). In the US, the bulk of fluctuations during war episodes can be mainly explained by the rise in government spending, and the war shock plays a minor role. In other countries, the war shock is an essential driver of fluctuations. We also discuss the size and state-dependence of public spending multipliers, and produce a counterfactual exercise to quantify the welfare losses from war episodes.