Scandinavian Working Papers in Economics

Working Paper Series,
Sveriges Riksbank (Central Bank of Sweden)

No 304: Jump-Starting the Euro Area Recovery: Would a Rise in Core Fiscal Spending Help the Periphery?*

Olivier Blanchard (), Christopher J. Erceg () and Jesper Lindé ()
Additional contact information
Olivier Blanchard: International Monetary Fund, Postal: 700 19th Street, N.W., Washington, D.C. 20431
Christopher J. Erceg: Federal Reserve Board, Postal: 20th Street and Constitution Avenue N.W., Washington, D.C. 20551
Jesper Lindé: Research Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden

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.

Keywords: Monetary Policy; Fiscal Policy; Liquidity Trap; Zero Bound Constraint; DSGE Model; Currency Union

JEL-codes: E52; E58

91 pages, July 1, 2015

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