In search of the transmission mechanism of fiscal policy in the euro area

Fève, Patrick; Sahuc, Jean-Guillaume

In search of the transmission mechanism of fiscal policy in the euro area

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Citation

Fève, P, Sahuc, J. In search of the transmission mechanism of fiscal policy in the euro area. 2016. handle: http://hdl.handle.net/10230/27302

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Abstract

This paper applies the DSGE-VAR methodology to assess the size of fiscal multipliers in the data and the relative contributions of two transmission mechanisms of government spending shocks, namely hand-to-mouth consumers and Edgeworth complementarity. Econometric experiments show that a DSGE model with Edgeworth complementarity is a better representation of the transmission mechanism of fiscal policy as it yields dynamic responses close to those obtained with the flexible DSGE-VAR model (i.e. an impact output multiplier larger than one and a crowding-in of private consumption). The estimated share of hand-to-mouth consumers is too small to replicate the positive response of private consumption.