Jump-Starting the Euro Area Recovery: Would a Rise in Core Fiscal Spending Help the Periphery?

Riksbank Research Paper Series No. 128

Sveriges Riksbank Working Paper Series No. 304

85 Pages Posted: 13 Aug 2015

See all articles by Olivier J. Blanchard

Olivier J. Blanchard

National Bureau of Economic Research (NBER); Peter G. Peterson Institute for International Economics

Christopher J. Erceg

Board of Governors of the Federal Reserve System

Jesper Lindé

Sveriges Riksbank - Research Division

Date Written: July 2015

Abstract

We show that a fiscal expansion by the core economies of the euro area would have a large and positive impact on periphery GDP assuming that policy rates remain low for a prolonged period. Under our preferred model specification, an expansion of core government spending equal to one percent of euro area GDP would boost periphery GDP around 1 percent in a liquidity trap lasting three years, about half as large as the effect on core GDP. Accordingly, under a standard ad hoc loss function involving output and inflation gaps, increasing core spending would generate substantial welfare improvements, especially in the periphery. The benefits are considerably smaller under a utility-based welfare measure, reflecting in part that higher net exports play a material role in raising periphery GDP.

Keywords: Monetary Policy, Fiscal Policy, Liquidity Trap, Zero Bound Constraint, DSGE Model, Currency Union

JEL Classification: E52, E58

Suggested Citation

Blanchard, Olivier J. and Erceg, Christopher J. and Linde, Jesper, Jump-Starting the Euro Area Recovery: Would a Rise in Core Fiscal Spending Help the Periphery? (July 2015). Riksbank Research Paper Series No. 128. Available at SSRN: https://ssrn.com/abstract=2635382 or http://dx.doi.org/10.2139/ssrn.2635382

Olivier J. Blanchard

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Peter G. Peterson Institute for International Economics ( email )

1750 Massachusetts Avenue, NW
Washington, DC 20036
United States

Christopher J. Erceg

Board of Governors of the Federal Reserve System ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2575 (Phone)
202-736-5638 (Fax)

Jesper Linde (Contact Author)

Sveriges Riksbank - Research Division ( email )

S-103 37 Stockholm
Sweden
+46 8 787 0873 (Phone)

HOME PAGE: http://www.riksbank.com

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