On the usefulness of government spending in the EU area

Abstract

This paper investigates the effects of government spending on private consumption and investment in the European Union (EU). A certain consensus has been reached on the expansionary Keynesian effects of fiscal impulses on the economic activity. However, the existing empirical literature has concentrated on few countries, mostly outside the EU. We check the validity of this result for the EU area using annual data and a panel vector auto-regression approach, with particular attention being paid to robustness across alternative identification assumptions based on Cholesky orderings. Our results show that shocks to public spending positively affect private consumption and investment. According to our baseline estimate, a 1% increase in public current expenditure produces a 0.24% impact rise in private consumption, and a 0.41% impact rise in private investment. The effects are substantial, and die out slowly in the case of private consumption (the cumulative impact amounts to +0.56% after 3 years), but much faster in the case of private investment. A further disaggregation between wage and non-wage components reveals that public salaries have a relatively stronger stimulating role. This is not due to the different weights on GDP of the two components, which have comparable values in our sample.