DP15894 The Transmission Channels of Government Spending Uncertainty
|Author(s):||Beliansk Anna, Aurélien Eyquem, Céline Poilly|
|Publication Date:||March 2021|
|Keyword(s):||Government spending uncertainty, portfolio adjustment cost, stochastic volatility|
|Programme Areas:||Monetary Economics and Fluctuations|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=15894|
Higher uncertainty about government spending generates a persistent decline in the economic activity in the Euro Area. This paper emphasizes the transmission channels explaining this empirical fact. First, a Stochastic Volatility model is estimated on European government consumption to build a measure of government spending uncertainty. Plugging this measure into a SVAR model, we stress that government spending uncertainty shocks have recessionary, persistent and humped-shaped effects. Second, we develop a New Keynesian model with financial frictions applying to a portfolio of equity and long-term government bonds. We argue that a portfolio effect -- resulting from the imperfect substitutability among both assets -- acts as a critical amplifier of the usual transmission channels.