Abstract

In this paper we study the response of unemployment to monetary policy and government spending shocks in the peripheral Euro-area countries. By applying the structural near-VAR methodology, we jointly model area-wide and national variables. Our main finding is that fiscal multipliers vary across countries and the results are consistent with the prediction of the standard New Keynesian model only in Italy and Greece. Instead, in Ireland, Portugal and Spain increases in government spending are recessionary. Thus we find that Keynesian results of fiscal policy seem to prevail in high public-debt countries, whereas non-Keynesian outcomes seem to characterize high private-debt countries. As for the monetary policy shock, we find that it plays an important role, jointly with the other area-wide shocks, as a long-term driver of national unemployment.

Highlights

  • Do contractionary fiscal policies, consisting in cut to government spending, produce recessionary effects in the economic system? Or, instead, do these policies cause expansions in economic activity? These are old debated issues in macroeconomics that, in the last decade, have known a revival, mainly as a consequence of the so-called Great Recession which hit the majority of industrialized countries and in the light of the related, dilemmatic choices of fiscal policy faced by governments.In this paper we aim to investigate these issues by focusing on a group of Euro-area countries in which fiscal austerity has been forced in recent years both by the European fiscal rules and by an economic and financial environment characterized by rising debt and related fears concerning its sustainability

  • For example we find that, at least for Greece and Italy, government spending shocks cause an expansion of the economy, i.e. in response to these shocks there is a decrease in unemployment and our results do not support the conclusion that fiscal multipliers in countries affected by high public debt exhibit a non-Keynesian sign

  • We find a clear confirmation of the main results obtained in section 3: Greece and Italy show Keynesian effects associated with fiscal policy, since the unemployment rate increases for many quarters in response to the government spending cut, while in Ireland, Portugal and Spain in response to the fiscal contraction there is both a significant and persistent decrease in the unemployment rate

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Summary

Introduction

Do contractionary fiscal policies, consisting in cut to government spending, produce recessionary effects in the economic system? Or, instead, do these policies cause expansions in economic activity? These are old debated issues in macroeconomics that, in the last decade, have known a revival, mainly as a consequence of the so-called Great Recession which hit the majority of industrialized countries and in the light of the related, dilemmatic choices of fiscal policy faced by governments. Identification in the Euro area-wide block is achieved by assuming that a monetary policy shock does not influence either the price level or unemployment within the period; a demand shock exerts a delayed effect on prices; the exchange rate does not exert a contemporaneous effect on the differential between Eonia and the federal funds rate nor on other Euro area variables.5 This orthogonalization of the structural shocks is widely adopted in the VAR literature studying the dynamic behaviour of large economies (see, for example, Christiano et al, 1999 and Eichenbaum-Evans, 1995). The remaining restrictions in the domestic block involve restricting to zero the contemporaneous response of the price level to a local aggregate demand shock, and ordering last in the VAR the interest rate differential between national and German bonds, an assumption consistent with the practice of considering financial variables as fast moving series that react quickly to economic developments.

The effects of economic shocks in the Euro area periphery
Common monetary policy shock
Domestic government spending shocks
The drivers of unemployment
An alternative identification strategy of government spending shocks
Identification based on imposing sign restrictions
Findings
Conclusion and some policy implications
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