By: Davide Furceri and Annabelle Mourougane
This paper examines the effects of fiscal policy on output in the euro area. For this purpose we develop a DSGE Fiscal Model with endogenous government bond yields to assess the impact of different fiscal policy shocks on output, its components and on government debt. The simulations suggest that fiscal policy is effective in supporting activity, especially in the short term. In particular, the largest fiscal multipliers are found for an increase in public investment, public consumption and a cut in the wage tax. The results are robust to different parameter calibrations and are economically significant. Amongst the different structural parameters, the share of liquidity constrained households and price persistence are found to be the ones which affect the most fiscal multipliers.
DSGE models do not find large multipliers from government expenses because the Ricardian Equivalence holds, or almost holds. In this paper, liquidity constraints allow for strong deviations from Ricardian Equivalence, and thus more substantial multipliers.