A Public Investment Stimulus in Surplus Countries and Its Spillovers in the EA

Abstract

The Euro Area recommendations endorsed by the European Council in 2016 called for a differentiation of the fiscal effort by individual Member States, taking into account spillovers across Euro Area countries. This article shows model-based simulations of an increase in public investment in Germany and the Netherlands and their spillovers to the rest of the Euro Area. While spillovers in a monetary union may be small when monetary policy reacts by raising interest rates, when rates are kept constant and the stimulus is accommodated, spillovers can be sizeable. An increase in (productive) spending in Germany and the Netherlands can boost GDP in these countries and also have significant positive spillovers on the rest of EA GDP, while the effects on current accounts are likely to be small. Effects can be even larger when investment is directed to the most productive projects. With low borrowing costs at present, the increase in government debt for surplus countries will be modest, while there could be an improvement in debt ratios in the rest of the Euro Area.

Spillover effects of Germany's final demand on Southern Europe

“…Our estimates complement existing ones derived from dynamic stochastic general equilibrium (DSGE) models (BMWi, ; Bundesbank, ; Elekdag & Muir, ; IMF, ; in't Veld, , ). DSGE models are grounded in theory; they incorporate a wide range of behavioural details and emphasise forward‐looking decision making by rational agents.…”

“…To our knowledge, the most recent incarnation of the QUEST model generates the largest spillover effects (in't Veld, ). The model used in that study is based on a slightly different country grouping, sets the output elasticity of public capital to a higher value and simulates a joint expansion of public investment in Germany and the Netherlands.…”

“…If we cast a wide net and allow the spillover effects produced by the closed input–output model to vary by a factor of two (half or twice the estimated size), all studies listed in Table would fall within these bounds except in't Veld (). The earlier version of the QUEST model (in't Veld, ) already produced relatively high spillover effects; the combination of long shock duration and high output elasticity of public capital in the more recent version of the model appears to account for this result.…”

Measuring fiscal spillovers in EMU and beyond: A Global VAR approach

“…Finally, the stance of monetary policy is also expected to influence spillover effects (Elekdag and Muir, ; Gadatsch et al ., ): Simulations depicted by In't Veld () generate evidence that debt‐financed increases in government investment in surplus countries have stronger positive GDP spillovers to other member states of the Euro area when monetary policy rates are held constant (e.g., when monetary policy is operating at the lower zero bound) (In't Veld, ). Bundesbank () and Cook and Devereux () assess the role of monetary policy for fiscal spillovers in the context of a currency union…”

“…The demand channel is the one that has been emphasized the most (In't Veld, ). As fiscal policy actions influence domestic demand, this should also affect (domestic) demand for foreign goods and thereby (net‐) exports of trading partners.…”