The Euro-Area Government Spending Multiplier at the Effective Lower Bound

The Euro Area Government Spending Multiplier in Demand- and Supply-Driven Recessions

“…Analogously to previous studies (see, e.g., Caggiano et al, 2015;Amendola et al, 2020; 2) conditional on the economy being in a recession and the inflation deviation from trend (cyclical inflation) being at the 26th (demanddriven recession) and the 76th percentiles of its distribution (supply-driven recession) at the time of the government spending shock. H identifies the number of quarters after the shock.…”

“…According to theory, a dominance of demand shocks is mirrored in more or less strong negative deviations of inflation from its trend, while the reverse applies to the case of dominant supply shocks. We discuss further important advantages of applying the Interacted Vector Autoregressive (IVAR) methodology and its generalizations in quantifying state-dependent policy effects in Amendola et al (2020) and Di .…”

“…Our paper is also related to an important strand of the literature that examines statedependence of the effects of fiscal policy. However, most of this literature focuses on whether fiscal policy is more effective in recessions and when the zero interest rate lower bound (ZLB) is binding (see, e.g., Auerbach and Gorodnichenko, 2012;Ramey and Zubairy, 2018;Miyamoto et al, 2018;Di Serio et al, 2020;Amendola et al, 2020).…”

“…This choice essentially treats the EA as a closed economy because it does not explicitly allow for external shocks to affect the endogenous variables. Therefore, in order to account for potentially important international factors that may influence our variables of interest, we add as exogenous variables also a set of U.S. variables (see, e.g., Amendola et al, 2020), including the U.S. output gap, U.S. inflation and the U.S. shadow monetary policy rate developed by Wu and Xia (2016).…”

“…Against this background, this paper quantifies the effects of government spending shocks in demand-and supply-driven recessions in the EA, with time series information on ten founding members of the EA. We estimate the effects of government spending shocks with a factor-augmented interacted panel VAR purified of expectations (FAIPVAR-X, building on Towbin and Weber, 2013;Sá et al, 2014;Amendola et al, 2020;Di Serio et al, 2020), using two interaction terms: the OECD recession indicator and inflation deviations from trend.…”