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Title: Jump-Starting the Euro Area Recovery: Would a Rise in Core Fiscal Spending Help the Periphery?

Author(s): Olivier J Blanchard, Christopher Erceg and Jesper Lindé

Publication Date: July 2015

Keyword(s): currency union, DSGE model, fiscal policy, liquidity trap, monetary policy and zero bound constraint

Programme Area(s): International Macroeconomics and Finance

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 around 1 percent in a liquidity trap lasting three years, about 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.

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Bibliographic Reference

Blanchard, O, Erceg, C and Lindé, J. 2015. 'Jump-Starting the Euro Area Recovery: Would a Rise in Core Fiscal Spending Help the Periphery?'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10716