DP14106 Local Autonomy and Government Spending Multipliers: Evidence from European Regions

Author(s): Markus Brueckner, Evi Pappa, Akos Valentinyi
Publication Date: November 2019
Keyword(s): elasticity of output to changes in government spending, Fiscal Decentralization, local autonomy index, multipliers, New Keynesian model of a monetary union, public spending hypothesis
JEL(s): E12, E32, E62, F33, R12
Programme Areas: Public Economics, International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14106

Using a panel of 268 European regions during 1990-2014, we document that the degree of local autonomy has a significant effect on the government spending multiplier. Measured with the "Local Autonomy Index" constructed by a panel of experts under the auspices of the European Commission, the estimated effect of regional government spending on regional output is on average close to zero in countries with the lowest degree of local autonomy, while it is around one in countries with the highest degree of local autonomy. Consistent with literature, we find that regional government spending multipliers are state dependent: larger when labor markets are slack and output is below trend than when labor markets are tight and output is above trend. Greater local autonomy increases the multipliers in all states, and more so when labor markets are slack and output is below trend. To explain the empirical findings, we build a DSGE model where both local and central government spending contributes to a public good that enhances productivity of the private sector.