How much did fiscal policy contribute to euro area real GDP growth during the Great Recession? We estimate that discretionary fiscal measures have increased annualized quarterly real GDP growth ...during the crisis by up to 1.6 percentage points. We obtain our result by using an extended version of the European Central Bank's New Area-Wide Model with a rich specification of the fiscal sector. A detailed modeling of the fiscal sector and the incorporation of as many as eight fiscal time series appear pivotal for our result. PUBLICATION ABSTRACT
The secular decline in the equilibrium real interest rate observed over the past decades has materially limited the room for policy-rate reductions in recessions, and has led to a marked increase in ...the incidence of episodes where policy rates are likely to be at, or near, the effective lower bound on nominal interest rates. Using the ECB’s New Area-Wide Model, we show that, if unaddressed, the effective lower bound can cause substantial costs in terms of worsened macroeconomic performance, as reflected in negative biases in inflation and economic activity, as well as heightened macroeconomic volatility. These costs can be mitigated by the use of nonstandard instruments, notably the joint use of interest-rate forward guidance and large-scale asset purchases. When considering alternatives to inflation targeting, we find that make-up strategies such as price-level targeting and average-inflation targeting can, if they are well-understood by the private sector, largely undo the negative biases and heightened volatility induced by the effective lower bound.
The predictive likelihood is useful for ranking models in forecast comparison exercises using Bayesian inference. We discuss how it can be estimated, by means of marginalization, for any subset of ...the observables in linear Gaussian state-space models. We compare macroeconomic density forecasts for the euro area of a DSGE model to those of a DSGE-VAR, a BVAR and a multivariate random walk over 1999:Q1–2011:Q4. While the BVAR generally provides superior forecasts, its performance deteriorates substantially with the onset of the Great Recession. This is particularly notable for longer-horizon real GDP forecasts, where the DSGE and DSGE-VAR models perform better.
We study the incidence and severity of periods with a binding effective lower bound on nominal interest rates and the efficacy of three types of state‐dependent policies—forward guidance about the ...path of future interest rates, large‐scale asset purchases, and spending‐based fiscal stimulus—in mitigating the detrimental consequences of the lower bound for macro‐economic stability. Based on the ECB's New Area‐Wide Model of the euro area, our findings suggest that, if left unaddressed, the lower bound can cause substantial macro‐economic distortions. In the near term, forward guidance, if fully credible, is most powerful and can largely undo these distortions. A combination of imperfectly credible forward guidance, asset purchases, and fiscal stimulus is almost equally effective, especially when asset purchases enhance the credibility of the forward‐guidance policy via a signaling effect. In the long run, with an equilibrium real rate as low as zero, a combination of all three policies is needed to materially reduce the distortions.
In this paper, we revisit the effects of government spending shocks on private consumption which have been at centre stage of the macroeconomic policy debate for quite a long time. We conduct our ...analysis in an estimated model of the euro area, which is representative of a new generation of dynamic stochastic general equilibrium (DSGE) models usable for quantitative policy analysis. We show that the inclusion of non‐Ricardian households, which simply consume their current disposable income, is in general conducive to raising the level of consumption in response to government spending shocks when compared with a benchmark specification without non‐Ricardian households. However, we find that there is only a fairly small chance that government spending shocks crowd in consumption, mainly because the estimated share of non‐Ricardian households is relatively low, but also because of the large negative wealth effect induced by the highly persistent nature of government spending shocks.
In this paper, we employ a calibrated two-country version of the New Area-Wide Model (NAWM) developed at the European Central Bank to examine the potential benefits and spillovers of reducing ...labour-market distortions caused by euro area tax structures. Our analysis shows that lowering tax distortions to levels prevailing in the United States would result in an increase in hours worked and output by more than 10%. At the same time, tax reductions would have positive spillovers to the euro area's trade partners, bolstering the case for tax reforms from a global perspective. Finally, we illustrate that, in the presence of heterogeneous households, distributional effects may be of importance when gauging the impact of tax reforms.
In this paper, we examine the macroeconomic effects of alternative fiscal consolidation policies in the New Area-Wide Model (NAWM), a two-country open-economy model of the euro area developed at the ...European Central Bank (cf. Coenen, G., McAdam, P., Straub, R., in press. Tax reform and labour-market performance in the euro area: a simulation-based analysis using the New Area-Wide Model. Forthcoming in the Journal of Economic Dynamics and Control). We model fiscal consolidation as a permanent reduction in the targeted government debt-to-output ratio and analyse both expenditure and revenue-based policies that are implemented by means of simple fiscal feedback rules. We find that fiscal consolidation has positive long-run effects on key macroeconomic aggregates such as output and consumption, notably when the resulting improvement in the budgetary position is used to lower distortionary taxes. At the same time, fiscal consolidation gives rise to noticeable short-run adjustment costs in contrast to what the literature on expansionary fiscal consolidations suggests. Moreover, depending on the fiscal instrument used, fiscal consolidation may have pronounced distributional effects.
In this paper we study the role of the exchange rate in conducting monetary policy in an economy with near-zero nominal interest rates as experienced in Japan since the mid-1990s. Our analysis is ...based on an estimated model of Japan, the United States and the euro area with rational expectations and nominal rigidities. First, we provide a quantitative analysis of the impact of the zero bound on the effectiveness of interest rate policy in Japan in terms of stabilizing output and inflation. Then we evaluate three concrete proposals that focus on depreciation of the currency as a way to ameliorate the effect of the zero bound and evade a potential liquidity trap. Finally, we investigate the international consequences of these proposals.
We estimate a small model of the euro area to be used for evaluating alternative monetary policy strategies. Starting with the relationship between output and inflation we compare the fit of the ...nominal wage contracting model due to Taylor (J. Political Econom. 88 (1980) 1) and the relative real wage contracting model proposed by Buiter and Jewitt (The Manchester School 49 (1981) 211; reprinted in Buiter (Ed.), Macroeconomic Theory and Stabilization Policy, Manchester University Press, Manchester, 1989) and estimated with U.S. data by Fuhrer and Moore (Quart. J. Econom. 110 (1995) 127). While Fuhrer and Moore reject nominal contracts in favor of relative contracts, which induce more inflation persistence, we find that both specifications fit euro area data reasonably well. When considering France, Germany and Italy separately, however, we find that nominal contracts fit German data better, while the relative contracting model does well with respect to formerly high inflation countries such as France and Italy. We close the model by estimating an aggregate demand relationship and investigate the implications of nominal versus relative contracts for the inflation-output variability tradeoff when monetary policy follows Taylor's rule.
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