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Debt and stabilization policy: Evidence from a Euro Area FAVAR

Laura Jackson Young (), Michael T. Owyang and Sarah Zubairy ()

Journal of Economic Dynamics and Control, 2018, vol. 93, issue C, 67-91

Abstract: The Euro Area poses a unique problem in evaluating policy: a currency union with a shared monetary policy and country-specific fiscal policy. Analysis can be further complicated if high levels of public debt affect the performance of stabilization policy. We construct a framework capable of handling these issues with an application to Euro Area data. In order to incorporate multiple macroeconomic series from each country but, simultaneously, treat country-specific fiscal policy, we develop a hierarchical factor-augmented VAR with zero restrictions on the loadings that yield country-level factors. Monetary policy, then, responds to area-wide conditions but fiscal policy responds only to its country-level conditions. We find that there is broad quantitative variation in different countries’ responses to area-wide monetary policy and both qualitative and quantitative variation in responses to country-specific fiscal policy. Moreover, we find that debt conditions do not diminish the effectiveness of policy in a significant manner, suggesting that any negative effects must come through other channels.

Keywords: Government spending; Monetary policy; European Monetary Union; Debt (search for similar items in EconPapers)
JEL-codes: C32 E58 E62 (search for similar items in EconPapers)
Date: 2018
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Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

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