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

This paper applies structural vector autoregressions with time-varying parameters in order to investigate changes in the effects of government spending shocks in the euro area, and the driving forces of those changes. Our contribution is two-fold. First, we present evidence that the short-run impact of government spending on real GDP and private consumption has increased until the end-1980s but it has decreased thereafter, along with a weaker response of the real wage and a stronger response of the nominal interest rate. Moreover, spending multipliers at longer horizons have declined substantially over the period 1980-2008. Second, exploiting state dependency using second-stage inference, we show that these changes can be traced back to increasing availability of credit and rising debt-to-GDP ratios in the euro area, as well as a smaller share of government investment and a larger share of public wages in total spending.