Fiscal stimulus in times of high debt: reconsidering multipliers and twin deficits

Christiane Nickel () and Andreas Tudyka

No 1513, Working Paper Series from European Central Bank

Abstract: We investigate the impact of fiscal stimuli at different levels of the government debt-to-GDP-ratio for a sample of 17 European countries from 1970 to 2010. This is implemented in an interacted panel VAR framework in which all coefficient parameters are allowed to change continuously with the debt-to-GDP ratio. We find that responses to government spending shocks exhibit strong non-linear behaviour. While the overall cumulative effect of a spending shock on real GDP is positive and significant at moderate debt-to-GDP ratios, this effect turns negative as the ratio increases. The total cumulative effect on the trade balance is negative at first but switches sign at higher levels of debt. Consequently, depending on the degree of public indebtedness, our results accommodate long-run fiscal multipliers which are greater and smaller than one or even negative as well as twin deficit and twin divergence behaviour within one sample and time period. From a policy perspective, these results lend additional support to increased prudence at high public debt ratios because the effectiveness of fiscal stimuli to boost economic activity or resolve external imbalances may not be guaranteed. JEL Classification: E62, F32, F41, C32, C11

Keywords: bayesian estimation; debt dynamics; fiscal policy; non-linearities; panel-VAR; trade account (search for similar items in EconPapers)
Date: 2013-02
New Economics Papers: this item is included in nep-opm, nep-pbe and nep-pub
Note: 166869
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (29)

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