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Global factors for local shocks in a data-scarce environment: with an application to regional fiscal multipliers in Italy

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  • Giuseppe Cavaliere
  • Luca Fanelli
  • Marco Mazzali

Abstract

We propose a novel econometric methodology for Structural Vector Autoregressions with external instruments (`proxy-SVARs' or `SVAR-IVs') in panel data characterized by strong cross-sectional dependence, dynamic heterogeneity, and limited availability of direct external instruments for the shocks of interest. For each unit, we specify a Factor-Augmented proxy-SVAR (`proxy-FA-SVAR') that incorporates factors summarizing cross-sectional information from the non-policy variables of the system. The effects of the policy shocks are then recovered indirectly by estimating unit-specific policy reaction functions through a Minimum Distance approach. Identification relies on global instruments for the non-policy shocks; that is, proxies common to all units in the panel, internally constructed from a separate SVAR estimated on factors for the policy and non-policy variables. These global instruments can be complemented with local (idiosyncratic) instruments constructed from auxiliary unit-level SVARs. Their joint use renders the proxy-FA-SVARs overidentified and therefore statistically testable. We illustrate the methodology by estimating government spending multipliers for Italian NUTS-2 regions using annual data. The global and local instruments for the regional output shocks are obtained from Blanchard-Perotti-type SVARs.

Suggested Citation

  • Giuseppe Cavaliere & Luca Fanelli & Marco Mazzali, 2026. "Global factors for local shocks in a data-scarce environment: with an application to regional fiscal multipliers in Italy," Papers 2607.13879, arXiv.org.
    • Handle: RePEc:arx:papers:2607.13879
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