Jump-Starting the Euro-Area Recovery: Would a Rise in Core Fiscal Spending Help the Periphery?

Abstract

We show that a fiscal expansion by the core economies of the euro area would have a large and positive impact on periphery GDP assuming that policy rates remain low for a prolonged period. Under our preferred model specification, an expansion of core government spending equal to 1% of euro-area GDP would boost periphery GDP by over 1%in a liquidity trap lasting three years, nearly half as large as the effect oncore GDP. Accordingly, under a standard ad hoc loss function involving output and inflation gaps, increasing core spending would generate substantial welfare improvements, especially in the periphery. The benefits are considerably smaller under a utility-based welfare measure, reflecting in part that higher net exports play a material role in raising periphery GDP.

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