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Tobias Cwik and Volker Wieland Goethe University of Frankfurt, CFS and CEPR

Banco de España Research Conference Madrid, February 25, 2010 Interactions between Monetary and Fiscal Policies. Keynesian Government Spending Multipliers and Spillovers in the Euro Area. Tobias Cwik and Volker Wieland Goethe University of Frankfurt, CFS and CEPR.

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Tobias Cwik and Volker Wieland Goethe University of Frankfurt, CFS and CEPR

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  1. Banco de España Research Conference Madrid, February 25, 2010 Interactions between Monetary and Fiscal Policies KeynesianGovernmentSpending Multipliers and Spillovers in the Euro Area Tobias Cwik and Volker Wieland Goethe University of Frankfurt, CFS and CEPR

  2. Heated Debate over Major Policy Experiments U.S.A.: 2008: tax rebates, 2009: ARRA American Recovery and Reinvestment Act, $ 787bln Europe: 2008/9: EERP The European Economic Recovery Plan, National plans: for example, in Germany, Konjunkturpaket 1 und 2 • Major discretionary fiscal policy initiatives with possibly large impact on economic welfare. • Heated debate in policy circles and academia: Convictions abound, competitors/opponents are easily dismissed.

  3. Quantitative Analysis and Policy Advice • Investigate the actual policy experiments, not standardized shocks. • Consider competing, empirically-based views of the structure of the economy (i.e. account for model uncertainty). • Account for a realistic range of scenarios (monetary-fiscal interactions, zero bound effect, implementation lags, …). • Policy advice should be robust! Develop decision criteria that account for competing model and realistic scenarios.

  4. Some Questions • How big is the actual € area stimulus? Which countries? • What GDP effects should we expect in the euro area? Is there a Keynesian multiplier effect or crowding out? • Account for model uncertainty and realistic scenarios. • What are the spillover effects between countries in the union? • We make use of a model archive that offers a new platform for a comparative approach to model-based policy analysis.

  5. 1. How big is the Euro area stimulus? Total Package in %GDP: 2009: 1.01 2010: 0.85 Expenditures in %GDP: 2010: 0.58 2010: 0.22 German stimulus 50 % of EU 11 German gov. expenditures: 43% of EU 11 German package %GDP: 3.37% (09: 1.44% 10: 1.93% )

  6. EU 11 Stimuli

  7. 2. What is the GDP effect of the Stimulus? Multipliers? • Focus on government spending which promises the largest multiplier. • Model uncertainty: consider wide range of competing Keynesian-style models, identical monetary policy reaction. • Alternative scenarios: • Actual spending plan (Immediate implementation with slight phase-in) • Implementation delay. • Zero bound: notional interest rate target negative  fiscal stimulus boosts output, but output increase does not immediately lead to policy tightening.

  8. Model Uncertainty & Robustness • New-Keynesian DSGE models: - Smets and Wouters 2003, (ECB), Euro Area - Laxton&Pesenti 2003 (IMF), Euro Area +Cz.Rep. - EU- Euro area model 2009 (EU-QUEST) (35% liquidity-constrained consumers) • New-Keynesian - Taylor G-7 model, 1993 • Old-Keynesian - ECB Area Wide model, 2004

  9. New-Keynesian DSGE Models of IMF and EU Researchers

  10. NK-Models The increase in GDP quickly produces a permanent contraction in private sector saving and consumption. Households anticipate that government debt incurred needs to be paid off with interest by raising taxes in the future. (SW-Small-IMF assume lump-sum/ non-distortionary taxes) Interest rates rise. Crowding out of investment and consumption. No multiplier.

  11. Taylor and ECB-AWM Models

  12. Scenario (2): Implementation Lag

  13. GDP Effect with Implementation Lag

  14. Consumption and Investment

  15. Consumption and Investment

  16. Scenario (3): Zero Bound and Monetary-Fiscal Policy Interaction • So far interest rates are set according to Gerdesmeier-Roffia (ECB) rule used also in Kuester-Wieland (JEEA, June, 2010) • Recession, nominal rate bounded at zero, central bank want to lower further  notional negative interest rate target  as long as it is below zero, fiscal stimulus boosts GDP without triggering policy tightening.

  17. Zero Interest Rate Floor • Cash is a zero-interest bearing asset • Technically: • nonlinear RE model • rational anticipation that zero interest floor becomes binding for 1 year • simulation: keep interest rate constant for 1 year, then return to Gerdesmeier-Roffia rule. Endogenous recession and zero bound (see example later).

  18. Zero Bound effective in 2009

  19. Decision Criteria: Robustness under Model Uncertainty • How to weigh the models? • Bayesian probabilities, equal weights, Minimax, ambiguity aversion (see also Kuester-Wieland 2010) • Here a simple criterion: • cumulative 2-year or 4-year multiplier negative or positive?

  20. Cumulative Effect(output net of government spending) • Crowding out dominates.

  21. 3. Spillover Effects • German stimulus greater, almost like ARRA for 2 years. • Do the other countries benefit, as supporters of fiscal stimulus predicted? • Need at least a 3-country model. We‘ll use Taylor (1993), G-7. • Impact of German stimulus on France and Italy

  22. Spillovers of German Package • No spillover, or even negative. • What effects are present?

  23. Spillovers of German Package 3 Effects: Direct positive demand effect on Italian and French exports. Significant in empirical export demand equation. Indirect negative effect 1: upward pressure on euro area interest rates. Indirect negative effect 2: euro real appreciation.

  24. Counterfactual: Flexible Exchange Rates between Germany, France and Italy Positive spillover once exchange rate effect reinforces it.

  25. Conclusions • Myth: „German package small“ • Spending multipliers: Confirms US analysis with multiple New Keynesian models, • Concentrated in 2 years, slightly greater multipliers. • Implementation lags mean effect in 09 Q1-2 negative. • 1-year constant rate increases multiplier little. • 2-4 years, signficant crowding-out. • Intra-euro area direct-demand spillovers dominated by negative interest-rate and exchange-rate effects.

  26. Appendix 1: What if ARRA applied in € Area?

  27. Counterfactual - What if ARRA implemented in Euro Area?

  28. Appendix 2: Recession and zero bound Baseline scenario: Simulate SW model with actual US data up to and including 2009:Q1. then project forward from 09:Q1 onwards with and without fiscal stimulus. Compute difference. with Fed following Taylor rule, the zero bound is not binding when simulating the SW 07 model. Use SW rule instead.

  29. 09:Q1 Deep recession and zero bound Counterfactual: consider deeper recessions. 1.5x the 09:Q1 shock, and 2x the 09:Q1 shock. The first scenario is similar to CCTW 1 year constrained.

  30. Projection and Realization: The Beginning of the Recovery • 09:Q1: Blue dashed: with ARRA spending. Black: no ARRA spending Red dashed: Actual Realizations Q2-Q4

  31. Appendix 3: Government Spending Shocks: Evidence from Reduced-Form Regressions Ramey (2009) says: “literature remains divided on central questions such as whether the GDP effect is greater than unity” “studies using VAR techniques in which identification is achieved by assuming that government spending is pre-determined within the quarter typically find a larger effect of government spending on GDP, while studies using the Ramey-Shapiro “war dates” indicate a smaller GDP effect and crowding-out of consumption.”

  32. Range of Estimates VAR-based estimates: Gali et al (2007), up to 1.7 Mountford & Uhlig (2009), below unity Other approaches to identification: Ramey (2009), 0.6-0.8 on defense spending when WWII is excluded, with WWII closer to unity. Barro & Redlick (2009), 0.6-0.7, defense spending including WWII, closer to 1 if unempoyment > 12%, non-defense spending multiplier insignificant.

  33. Anticipations Matter.

  34. Appendix 4: Eine Idee zur Exitstrategie Ein Konsumstimulus der etwas anderen Art. Problem bisher: Staatsausgabenerhöhung verdrängt privaten Konsum und Investitionen. Alternative: Ankündigung eines zukünftigen Sparpakets. Beispiel – USA American Savings Pact (ASPA = -2.5 x ARRA start in 2010:Q3)

  35. Gespart: 2.5 mal Ausgaben unter ARRA

  36. Appendix 5: Ein Blick auf die Daten • Was hat sich zwischen 09:Q1 und 09:Q2 geändert? • Können wir daraus Schlüsse ziehen, bezüglich der Wirkung verschiedener Maßnahmen?

  37. U.S.A.: Quartalswachstum (siehe auch Wall Street Journal (U.S.), 17.9.09, Cogan, Taylor, Wieland.) Beiträge zu Quartalswachstum- raten (annualisiert)

  38. €-Zone: Quartalswachstum (nicht annualisiert)

  39. Deutschland Beitrag zum BIP Wachstum (Quartalsraten, annualisiert)

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