Working Paper: NBER ID: w21426
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 by over 1 percent in a liquidity trap lasting three years, nearly 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: Fiscal policy; Euro area; Liquidity trap; Economic recovery; GDP spillovers
JEL Codes: E62; F41; F45
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| core fiscal expansion (E62) | periphery GDP (F69) |
| core fiscal expansion (E62) | periphery GDP (in liquidity trap) (E20) |
| liquidity trap duration (E41) | periphery GDP response (F69) |
| core fiscal expansion (E62) | net exports (F29) |
| net exports (F29) | periphery GDP (F69) |
| core fiscal expansion (E62) | inflation dynamics (E31) |
| inflation dynamics (E31) | periphery GDP (F69) |
| core fiscal expansion (E62) | interest rates (E43) |
| interest rates (E43) | periphery GDP (F69) |
| core fiscal expansion (E62) | welfare improvements (I38) |
| core fiscal expansion (E62) | slower consumption response (D12) |