Drivers of International Fiscal Spillovers

Abstract

This paper investigates the drivers of international fiscal spillovers across 62 countries for the period covering 1970-2021. Using the local projections method at the country-pair level, fiscal spillovers are estimated as the cumulative response of the real GDP growth in spillover destination countries to a unit shock in the real government spending growth in spillover source countries. Pairwise estimation results (for 3782 country pairs) suggest that there are statistically significant fiscal spillovers for 36% of country pairs, whereas this ratio is 49% for country pairs within the euro area. For the median country pair, a unit shock of real government spending growth in the spillover source country results in about 0.09% of an increase in the real GDP growth of the spillover destination country, whereas this fiscal-spillover estimate goes up to 0.42% when the spillover source is in the euro area and the spillover destination is an oil producing country. A secondary investigation based on the Heckman selection model is used to identify the drivers of fiscal spillovers across country pairs, where the existence of statistically significant fiscal spillovers is shown to be connected to the proximity between countries. The size of fiscal spillovers is further shown to increase with the initial (as of 1970) country size, trade openness, and government size of the spillover source country, whereas it decreases with the initial country size and trade openness of the spillover destination country. Important policy suggestions follow.

Keywords: Fiscal Spillovers, Country Pairs, Proximity, Country Characteristics

JEL Classification: F41, F42