Fiscal Stimulus in Times of High Debt: Reconsidering Multipliers and Twin Deficits

42 Pages Posted: 5 Mar 2013

See all articles by Christiane Nickel

Christiane Nickel

European Central Bank (ECB)

Andreas Tudyka

WHU - Otto Beisheim School of Management

Date Written: February 8, 2013

Abstract

We investigate the impact of fiscal stimuli at different levels of the government debt-to-GDP-ratio for a sample of 17 European countries from 1970 to 2010. This is implemented in an interacted panel VAR framework in which all coefficient parameters are allowed to change continuously with the debt-to-GDP ratio. We find that responses to government spending shocks exhibit strong non-linear behaviour. While the overall cumulative effect of a spending shock on real GDP is positive and significant at moderate debt-to-GDP ratios, this effect turns negative as the ratio increases. The total cumulative effect on the trade balance is negative at first but switches sign at higher levels of debt. Consequently, depending on the degree of public indebtedness, our results accommodate long-run fiscal multipliers which are greater and smaller than one or even negative as well as twin deficit and twin divergence behaviour within one sample and time period. From a policy perspective, these results lend additional support to increased prudence at high public debt ratios because the effectiveness of fiscal stimuli to boost economic activity or resolve external imbalances may not be guaranteed.

Keywords: Fiscal policy, debt dynamics, trade account, non-linearities, Bayesian estimation, panel-VAR

JEL Classification: E62, F32, F41, C32, C11

Suggested Citation

Nickel, Christiane and Tudyka, Andreas, Fiscal Stimulus in Times of High Debt: Reconsidering Multipliers and Twin Deficits (February 8, 2013). ECB Working Paper No. 1513, Available at SSRN: https://ssrn.com/abstract=2213878 or http://dx.doi.org/10.2139/ssrn.2213878

Christiane Nickel (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Andreas Tudyka

WHU - Otto Beisheim School of Management ( email )

Burgplatz 2
Vallendar, 56179
Germany

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