Multilateral Economic Cooperation and the International Transmission of Fiscal Policy

Abstract

The problem of fiscal policy coordination across countries has been thrust into the spotlight by the Great Recession The authors attack this question using both theory and empirics, and find evidence that, using standard identification methods, US fiscal shocks do generate quite large spillovers across the Atlantic. In theory it is quite hard to generate large cross-border spillovers: the “financial channel” matters, but doubts about solvency would undermine the mechanism. Thus international coordination may be helpful if it creates and sustains “fiscal space” so that truly solvent countries avoid self-fulfilling sovereign crises.

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