Fiscal policy shocks and international spillovers

The domestic and international transmission mechanism of fiscal policy shocks are analysed in large developed economies. Using a Bayesian VAR approach, we find that fiscal expansions are associated with increases in output, private consumption and, in many cases, with an in- crease in private investment. The terms of trade, which affect the international transmission of fiscal policy shocks, are found to depreciate in response to a fiscal expansion, thus transferring some of the increased domestic purchasing power abroad. A US government spending shock is expansionary for all non-US G7 members. A German government spending shock is expansion- ary for most, but not all European economies, both within and outside the Euro Area. The dynamics of the BVAR are rationalised using a dynamics stochastic general equilibrium model where heterogeneous households and firms face borrowing constraints.