Multilateral Economic Cooperation and the International Transmission of Fiscal Policy

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.

Macroeconomic and financial implications of multi‐dimensional interdependencies between OECD countries

“…Another important thread in the links between economies is found in the exchange of financial resources. The financial channel of transmission has been studied in the context of macroeconomic policies by Faini (2006) with special attention to interest rates and fiscal spillovers as well as by Corsetti and Müller (2011) who conclude on the dominant effect of financial factors in an international transmission mechanism that operates on domestic and foreign private spending through expectations, interest rates and international asset markets, in that sequence, extending the study on the role and impact on private spending of the sovereign risk channel as analysed in Corsetti, Pericoli, and Sbracia (2011) in an international, interdependent context.…”

Fiscal Multipliers and Their Relevance in a Currency Union – A Survey

“…Put differently, fiscal measures during financial crises are likely to impact economic activity strongly. The result is particularly noteworthy given the policy measures implemented during the global financial crisis (see Corsetti and M€ uller (2011) for an overview). Moreover, in light of the discussion in section 2 above, the result suggests that austerity measures during financial crises may well be self-defeating.…”