Fiscal Policy Shocks and International Spillovers

Abstract

The domestic and international transmission mechanism of fiscal policy shocks are analysed in large developed economies. Using a Bayesian VAR approach, we find that fiscal expansions are associated with increases in output, private consumption and, in many cases, with an increase in private investment. The terms of trade, which affect the international transmission of fiscal policy shocks, are found to depreciate in response to a fiscal expansion, thus transferring some of the increased domestic purchasing power abroad. A US government spending shock is expansionary for all non-US G7 members. A German government spending shock is expansionary for most, but not all European economies, both within and outside the Euro Area. The dynamics of the BVAR are rationalise using a dynamics stochastic general equilibrium model where heterogeneous households and firms face borrowing constraints.