Debt and Stabilization Policy: Evidence from a Euro Area FAVAR

55 Pages Posted: 7 Sep 2017 Last revised: 5 Jan 2019

See all articles by Laura E. Jackson

Laura E. Jackson

Bentley University - Department of Economics

Michael Owyang

Federal Reserve Bank of St. Louis - Research Division

Sarah Zubairy

Texas A&M University - Department of Economics

Date Written: 2017-07-27

Abstract

The Euro-area poses a unique problem in evaluating policy: a currency union with a shared monetary policy and country-specific fiscal policy. Analysis can be further complicated if high levels of public debt affect the performance of stabilization policy. We construct a framework capable of handling these issues with an application to Euro-Area data. In order to incorporate multiple macroeconomic series from each country but, simultaneously, treat country-specific fiscal policy, we develop a hierarchical factor-augmented VAR with zero restrictions on the loadings that yield country-level factors. Monetary policy, then, responds to area-wide conditions but fiscal policy responds only to its country level conditions. We find that there is broad quantitative variation in different countries'' responses to area-wide monetary policy and both qualitative and quantitative variation in responses to country-specific fiscal policy. Moreover, we find that debt conditions do not diminish the effectiveness of policy in a significant manner, suggesting that any negative effects must come through other channels.

Keywords: Government spending, monetary policy, European Monetary Union, debt

JEL Classification: C32, E58, E62

Suggested Citation

Jackson Young, Laura and Owyang, Michael T. and Zubairy, Sarah, Debt and Stabilization Policy: Evidence from a Euro Area FAVAR (2017-07-27). FRB St. Louis Working Paper No. 2017-22, Available at SSRN: https://ssrn.com/abstract=3029764 or http://dx.doi.org/10.20955/wp.2017.022

Laura Jackson Young (Contact Author)

Bentley University - Department of Economics ( email )

175 Forest Street
Waltham, MA 02452-4705
United States

Michael T. Owyang

Federal Reserve Bank of St. Louis - Research Division ( email )

411 Locust St
Saint Louis, MO 63011
United States

Sarah Zubairy

Texas A&M University - Department of Economics ( email )

5201 University Blvd.
College Station, TX 77843-4228
United States

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