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Federal Reserve Bank of St. Louis
Working Papers
Debt and Stabilization Policy: Evidence from a Euro Area FAVAR
Laura E. Jackson
Michael T. Owyang
Sarah Zubairy

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.

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Laura E. Jackson & Michael T. Owyang & Sarah Zubairy, Debt and Stabilization Policy: Evidence from a Euro Area FAVAR, Federal Reserve Bank of St. Louis, Working Papers 2017-22, 27 Jul 2017, revised 13 Oct 2017.
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Keywords: Government spending; monetary policy; European Monetary Union; debt
DOI: 10.20955/wp.2017.022
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