Working Paper: CEPR ID: DP15894
Authors: Anna Belianskaya; Aurelien Eyquem; Celine Poilly
Abstract: Higher uncertainty about government spending generates a persistent decline in the economic activity in the Euro Area. This paper emphasizes the transmission channels explaining this empirical fact. First, a Stochastic Volatility model is estimated on European government consumption to build a measure of government spending uncertainty. Plugging this measure into a SVAR model, we stress that government spending uncertainty shocks have recessionary, persistent and humped-shaped effects. Second, we develop a New Keynesian model with financial frictions applying to a portfolio of equity and long-term government bonds. We argue that a portfolio effect -- resulting from the imperfect substitutability among both assets -- acts as a critical amplifier of the usual transmission channels.
Keywords: government spending uncertainty; stochastic volatility; portfolio adjustment cost
JEL Codes: E62; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government spending uncertainty (H69) | GDP (E20) |
| government spending uncertainty (H69) | private consumption (D19) |
| government spending uncertainty (H69) | private investment (E22) |
| government spending uncertainty shocks (E62) | economic activity (E20) |
| government spending uncertainty shocks (E62) | recessionary effects (E32) |
| financial frictions (G19) | amplification of effects (C92) |