Trade spill-overs of fiscal policy in the European Union: a panel analysis

We explore the international spill-overs from fiscal policy shocks via trade in Europe. A fiscal expansion stimulates domestic activity, which leads to more foreign exports and, hence, higher foreign output. To quantify this, we combine a panel VAR model in government spending, net taxes and GDP with a panel trade model. We find statistically significant spill-overs. Our baseline estimates imply that, on average, over the first two years a German public spending increase equal to 1% of GDP implies an average foreign exports gain of 2.2% of its annual level. The corresponding figure for an equal-size net tax reduction is 0.8%. As far as the direct effect of enhanced exports on foreign activity is concerned, the corresponding average gains from the two shocks are, respectively, 0.13% and 0.07% of annual GDP. Of course, these numbers are (substantially) smaller when the fiscal shock originates from smaller EU countries.