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The Government Spending Multiplier at the Zero Lower Bound: Evidence from the Euro Area

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  • AMENDOLA, Adalgiso

    () (CELPE - Centre of Labour Economics and Economic Policy, University of Salerno - Italy)

  • DI SERIO, Mario

    () (CELPE - Centre of Labour Economics and Economic Policy, University of Salerno - Italy)

  • FRAGETTA, Matteo

    () (CELPE - Centre of Labour Economics and Economic Policy, University of Salerno - Italy)

Abstract

We use an Interacted Panel Vector Autoregressive (IPVAR) model, to investigate the effects of a government spending shock when the interest rate is at zero lower bound (ZLB). We also compare the responses of variables of interest at the ZLB with what we get when a government spending shock occurs in normal times (i.e. when the interest rate is larger than 0.25). We identify the government spending shock by sign restrictions and use the European Commission forecasts of government expenditure to account for fiscal foresight. For the baseline specification we find lower multipliers in times in which the ZLB is binding. However, fiscal foresight is not the only problem in fiscal VARs related to limited information problems. Usually, VAR models can only consider a limited number of variables due to degree of freedom problems. Several authors have shown (see Stock and Watson(2005) for a survey) how principal components extracted from a larger number of variables, can approximate unobserved factors driving most (if not all) of the macroeconomic variables. Therefore, we develop a Factor-Augmented IPVAR model (FAIPVAR) and find that the multipliers are very similar among states, ranging between 1.08 and 1.41 at the ZLB and between 1.26 and 1.39 away from it. We also divide our sample, considering two groups of countries in terms of high and low debt-to-GDP ratios. We find that countries with high levels of debt-to-GDP ratio show relatively lower multipliers. Considering the FAIPVAR model, the government spending multiplier ranges between 2.69 and 3.54 for core countries and between 0.82 and 1.37 for peripheral countries. Therefore, our findings support some recent studies, which suggest that the government spending multiplier is even larger if the debt-to-GDP ratio is low.

Suggested Citation

  • AMENDOLA, Adalgiso & DI SERIO, Mario & FRAGETTA, Matteo, 2018. "The Government Spending Multiplier at the Zero Lower Bound: Evidence from the Euro Area," CELPE Discussion Papers 153, CELPE - Centre of Labour Economics and Economic Policy, University of Salerno, Italy.
  • Handle: RePEc:sal:celpdp:0153
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    Keywords

    Interacted VAR; Fiscal Policy; Public Debt; Government Spending: Zero Lower Bound;

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H50 - Public Economics - - National Government Expenditures and Related Policies - - - General

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