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.