Working Paper Series no. 585: In Search of the Transmission Mechanism of Fiscal Policy in the Euro Area.

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.

Patrick Fève and Jean-Guillaume Sahuc
March 2016

Classification JEL : C32, E32, E62.

Keywords : Fiscal multipliers, hand-to-mouth, Edgeworth complementarity, DSGE-VAR, Euro area, Bayesian econometrics.