Transmission of government spending shocks in the Euro area: time variation and driving forces

This paper provides new evidence on the effects of government spending
shocks and the fiscal transmission mechanism in the euro area for the period
1980-2008. Our contribution is two-fold. First, we investigate changes in the
macroeconomic impact of government spending shocks using time-varying
structural VAR techniques. The results show that the short-run effectiveness
of government spending in stabilizing real GDP and private consumption has
increased until the end-1980s but it has decreased thereafter. Moreover, government
spending multipliers at longer horizons have declined substantially
over the sample period. We also observe a weaker response of real wages
and a stronger response of the nominal interest rate to spending shocks.
Second, we provide econometric evidence on the driving forces behind the
observed time variation of spending multipliers. We find that a higher ratio
of credit to households over GDP, a smaller share of government investment
and a larger share of public wages over total government spending have led
to decreasing contemporaneous multipliers. At the same time, our results
indicate that higher government debt-to-GDP ratios have negatively affected
long-term multipliers.
Keywords: Government spending shocks; Fiscal transmission mechanism; Structural change;
Bayesian analysis; Structural vector autoregressions; Time-varying parameter models
JEL classification: C32; E62; H30; H50