Working Paper: CEPR ID: DP8748
Authors: Giancarlo Corsetti; Gernot Müller
Abstract: During the global financial crisis 2007--2009 fiscal policy was widely used as a stabilization tool. Policymakers allowed a large build-up of public debt resulting from both automatic and discretionary expansionary measures. At the same time, calls for policy coordination stressed that international spillovers of fiscal policy might be sizeable. We reconsider the case for fiscal coordination by providing new evidence on the cross-border effects of discretionary fiscal measures. We rely on a vector autoregression model as well as on a quantitative business cycle model. We find that i) large spillover effects cannot be ruled out and, in contrast to conventional wisdom, ii) financial factors rather than trade flows lie at the heart of the international transmission mechanism. We discuss the implications of these results for policy coordination when markets price sovereign default risk, and put pressure on governments for implementing budget consolidation measures.
Keywords: Financial Crisis; Fiscal Policy Coordination; Government Spending; Spillover Effects
JEL Codes: E62; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| U.S. government spending increase (H56) | Euro Area output increase (O52) |
| U.S. government spending increase (H56) | UK output increase (O49) |
| Dollar depreciation (F31) | output spillovers (F69) |
| Expectations of future fiscal and monetary policies (E60) | current private expenditure (E20) |