Changing Patterns of Domestic and Cross-Border Fiscal Policy Multipliers in Europe and the US

CEPII Working Paper No. 2006-24

63 Pages Posted: 29 May 2007

See all articles by Agnès Bénassy-Quéré

Agnès Bénassy-Quéré

Paris School of Economics (University Paris 1)

Jacopo Cimadomo

European Central Bank

Date Written: December 2006

Abstract

This paper documents time variation in domestic fiscal policy multipliers in Germany, the UK and the US, and in cross-border fiscal spillovers from Germany to the seven largest European Union economies. We propose two VAR models which incorporate three "global factors" representing developments in the world economy, and we combine them with identification of fiscal shocks à la Blanchard and Perotti (2002) and Perotti (2005), to study the effects of net tax and government spending shocks on GDP, inflation and interest rates. By recursively estimating these models on different samples of data, we find that the domestic impact of tax shocks has been positive but vanishing for Germany and the US, stably not significant for the UK. Financial markets deregulations may play an important role in that since they allow households to be less dependent on disposable income and to smooth more easily consumption. Domestic government spending multipliers are found to be positive but feeble in the short-run and close to zero or slightly negative in the medium-run, implying that private consumption and investments might be crowded out. These results suggest that, in the European Monetary Union, discretionary fiscal policy "surprises" (i.e. unexpected tax cuts and government spending expansions) cannot be used by governments as substitutes for lost national monetary instruments, since they have shown to be progressively ineffective over time. Finally, we find that fiscal expansions in Germany have had beneficial (though declining) effects for neighboring countries, especially the smaller ones. This may indicate that the trade channel of transmission of fiscal policy dominates the interest rate one.

Keywords: Fiscal policy effectiveness, fiscal shocks, spillovers, factor-augmented VAR

JEL Classification: E30, E62, H30

Suggested Citation

Benassy-Quere, Agnes and Cimadomo, Jacopo, Changing Patterns of Domestic and Cross-Border Fiscal Policy Multipliers in Europe and the US (December 2006). CEPII Working Paper No. 2006-24, Available at SSRN: https://ssrn.com/abstract=989168 or http://dx.doi.org/10.2139/ssrn.989168

Agnes Benassy-Quere

Paris School of Economics (University Paris 1) ( email )

106-112 boulevard de l'Hopital
Paris, F-75013
France
+33 1 44 07 82 19 (Phone)

HOME PAGE: http://www.parisschoolofeconomics.com/benassy-quere-agnes/agnesb.html

Jacopo Cimadomo (Contact Author)

European Central Bank ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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