A presentation by Krzysztof Bankowski (European Central Bank) at the Workshop on Public Finances in Riga on 21 June 2016

1. Discussion: Fiscal
Spillovers in the Euro
Area: Sign, Size and
Determinants
by Georgios Georgiadis and Josef Hollmayr
Krzysztof Bankowski
Economist
Fiscal Policies Division
European Central Bank
WGPF Workshop
21 June 2016
Riga

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• How big are fiscal spill-over effects in the euro area?
• What determines fiscal spill-over effects?
• Both questions are very relevant:
– at the current juncture: frequent calls to member states with fiscal space to
support the euro area fiscal stance; background slide
– more recently: sizable fiscal consolidation effort in the euro area
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Summary/ objectives and modelling framework
Aim of the paper / main research questions
Modelling framework
VARX
(G)VAR
(MCS)(G)VAR
Foreign variables as an exogenous component
Various sections, most notably for monetary policy

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Summary/ model specification
EA country Non-EA country EA mon. policy Oil
Output Output
Prices Prices
Gov. spending
Interest rate EA Int. rate
Exchange rate
Oil price
Foreign output Foreign output EA output Global output
Foreign prices Foreign prices EA prices Global prices
Foreign gov. spending
Foreign + EA int. rate Foreign int. rate Foreign int. rate Global interest rate
Exchange rate Exchange rate
Oil price Oil price Oil price
US endog. variables US endog. variables US endog. variables US endog. varialbes

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• Sign restriction specification (1+1+11+1=14)
– Domestic gov. spending 
– domestic GDP 
– (domestic CPI – each foreign EA country CPI) 
– EUR exchange rate 
• Regression analysis
Spill-overrs = rs varrs + r  varr + s vars + urs
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Summary/ two stages
– varrs
• Imports of coutry r from country s
• Spill-over susceptibiilty
• Difference in the global value chain
• Contiguity
• Common language
• Distance
– varr and vars
• Fiscal deficit and debt
• Current account
• NFA
• Centrality

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• On government spending fiscal multipliers
– sizable on impact given the values of 0.5-1.5 for most of the EA countries
– lower in the long run, below 1 for almost all countries and even negative for
some
• On fiscal spill-over effects
– Limited, albeit non-negligible, on impact; for many countries spill-over ratios
exceeding 10%
– Virtually non-existent in the long run
• On determinants of spill-over effects in the euro area
– Both direct and indirect trade transmission channels play a role; they
materialise through retail activity, tourism and manufacturing
– Receiving country: fiscal debt  and CA balance  > spill-over effects 
– Sending country: gov. size  and centrality  > spill-over effects 
– Unclear role of the interest rate channel
5
Summary/ main findings

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Comments/ Spill-over channels (1)
• Trade interlinkages
– Implicitly reflected in the VAR framework
– Studied in detail using regressions
– The significance of this channel consistent with the literature, e.g. Beetsma et
al. (2006)
• Exchange rate
– Very relevant channel according to Cwik and Wieland (2011), direct trade
effect can be overwhelmed by the indirect effect of a real appreciation of the
euro
– Here explicit consideration of the rest of the world and exchange rate in the
model

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Comments/ Spill-over channels (2)
• Interest rate
– In the theoretical literature a very prominent channel
– No restriction imposed gives opportunity to analyse it
– Results could be very different if monetary policy remains accommodative like
currently – conditional forecast with interest rates fixed
Chart: Government spending spill-over effects from Germany to the rest of the euro area
Source: Own simulations using EAGLE model.
Notes: The spending shock in the simulation constitutes 1% of GDP spending increase split evenly between public purchases and investment. While the
shock is one-period it is persistent with 0.9 parameter on the autoregressive component. The standard monetary policy rule involves 0.1 coefficient on
output gap and 1.7 on inflation deviation. A more responsive version of it involves 0.125 and 2.5 parameters respectively.

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Comments/ methodology (1)
• Shock identification with sign restrictions
– Generalised IRF: do not answer policy relevant questions
– Cholesky: too many variables
– Long run restrictions: not possible given the model in differences
– Sign restrictions like by Mountford and Uhlig (2009): can be very useful
– BUT: are other business cycle shocks excluded by the identification scheme?
This requires counter-cyclical government spending.
• MU (2009) do not impose it and find that (differently defined) government spending is
pro-cyclical
• It is difficult to assume that total government expenditure is always counter-cyclical,
Barhoumi et al (2016) claim that cyclicality is shock type dependent
– MOREOVER: instantaneous response of prices vs. price stickiness
– FURTHERMORE: “very” transitory fiscal shocks
Source: European Commission’s Report on Public Finances in EMU 2015

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Comments/ methodology (2)
• The application of MSCGVAR
– Global VAR allows to overcome the problem of too many variables
– Mixed sections enable to embed common monetary policy
– Global factors are captured with oil price, perhaps other factors could be
verified in the spirit of FAVAR, see Cimadomo and Benassy-Quere (2012)
• Underlying period of analysis
– Auberbach and Gorodnichenko (2015) and other papers agree that spill-over
effects are limited in normal times but can be sizable during recessions, which
is related to the ZLB consideration
• Regressions with determinants of spill-over effects
– The regressions use maximum output growth spill-over effect; the application
of averages leads to significantly lower and insignificant coefficients. Can one
add some information on how representative is the maximum for the entire
effect?
– Naturally, the size of the sending country is a relevant factor for spill-over
effects. Was this investigated in the regressions?
• Presentational issues
– Spill-over effects could be reported in smaller intervals to provide more exact
estimates

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Overall
• Extremely relevant topic and a promising paper
• Appealing methodology allowing to address multiple relevant
points
• Fiscal shock identification strategy may need more fine-tuning
• Answering policy question which is at the heart of the current
debate will still require more work

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Background slide/ stabilisation need and fiscal space by the EC
Chart: 2016 change in the structural primary balance as implied by stabilisation and sustainability
needs
Source: European Commission’s Report on Public Finances in EMU 2015