DP10716 Jump-Starting the Euro Area Recovery: Would a Rise in Core Fiscal Spending Help the Periphery?

Author(s): Olivier J Blanchard, Christopher Erceg, Jesper Lindé
Publication Date: July 2015
Keyword(s): currency union, DSGE model, fiscal policy, liquidity trap, monetary policy, zero bound constraint
JEL(s): E52, E58
Programme Areas: International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10716

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.