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

Abstract

We build a factor-augmented interacted panel vector-autoregressive model of the Euro Area (EA) and estimate it with Bayesian methods to compute government spending multipliers. The multipliers are contingent on the overall monetary policy stance, captured by a shadow monetary policy rate. In the short run (one year), whether the fiscal shock occurs when the economy is at the effective lower bound (ELB) or in normal times does not seem to matter for the size of the multiplier. However, as the time horizon increases, multipliers diverge across the two regimes. In the medium run (three years), the average multiplier is about 1 in normal times and between 1.6 and 2.8 at the ELB, depending on the specification. The difference between the two multipliers is distributed largely away from zero. More generally, the multiplier is inversely correlated with the level of the shadow monetary policy rate. In addition, we verify that EA data lend support to the view that the multiplier is larger in periods of economic slack, and we show that the shadow rate and the state of the business cycle are autonomously correlated with its size. The econometric approach deals with several technical problems highlighted in the empirical macroeconomic literature, including the issues of fiscal foresight and limited information.

The Impact of r-g on the Euro-Area Government Spending Multiplier

“…The empirical model is an extension of the factor-augmented interacted panel vector-autoregressive model purified of expectations (FAIPVAR-X) of Amendola et al (2020), which in turn builds on the Interacted Vector Auto-Regressive (I-VAR) framework developed by Caggiano et al (2017). To allow for as much heterogeneity as possible, we utilize a panel model with fixed effects and heterogeneous slopes, which we estimate using the mean group estimator.…”

“…Therefore, we follow an approach compatible to Bayesian inference. Analogously to Caggiano et al (2015) and Amendola et al (2020), we compute empirical distributions of the differences computed as multipliers conditional on the economy being in the negative r−g regime minus multipliers conditional on the economy being in the positive r − g regime, and verify whether a very large part of the distributions include zero or not. In particular, for each of the 10,000 parameter draws from the posterior distribution, we compute the multipliers as in Equation 3, evaluate them for the two regimes, and compute the difference between the two.…”

“…The estimates are derived from a factor-augmented interacted panel vector-autoregressive model purified of expectations (FAIPVAR-X). This setup is an extension of the I-VAR model by Caggiano et al (2017), which we recently used to estimate fiscal multipliers at the ELB for the EA (Amendola et al, 2020). Using this framework has four advantages.…”

“…The second strand of the literature encompasses studies on the state dependency of fiscal multipliers on a variety of macroeconomic indicators. Common conditioning variables are the state of the business cycle (Auerbach and Gorodnichenko, 2012;Batini et al, 2012;Caggiano et al, 2015;Ramey and Zubairy, 2018, among others); monetary policy regimes, with a focus on the ELB (Miyamoto et al, 2018;Amendola et al, 2020;Bonam et al, 2020, among others); and the level of government debt ( Kirchner et al, 2010;Nickel and Tudyka, 2014, among others). Our paper bridges these two strands of the literature for the first time, by linking the size of the government spending multiplier to…”

The Government Spending Multiplier at the Zero Lower Bound: Evidence from the United States

“…More recently, Amendola et al . (2019) build on the ideas and methods in our paper and estimate a panel version of our model for the Euro Area. Their findings are consistent with our findings.…”