Working Paper: CEPR ID: DP10716
Authors: Olivier Blanchard; Christopher J. Erceg; Jesper Lind
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: currency union; DSGE model; fiscal policy; liquidity trap; monetary policy; zero bound constraint
JEL Codes: E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| liquidity trap (E41) | effectiveness of core spending on periphery GDP (F62) |
| monetary policy (E52) | effects of fiscal expansion (E62) |
| core fiscal spending (E62) | periphery GDP (F69) |
| higher government spending in the core (H56) | aggregate demand (E00) |
| aggregate demand (E00) | periphery GDP (F69) |
| core fiscal spending (E62) | real net exports (F14) |
| real net exports (F14) | periphery GDP (F69) |