Title: Debt and stabilization policy: Evidence from a Euro area FAVAR
Authors: Laura Jackson Young - Bentley University (United States) [presenting]
Michael Owyang - Federal Reserve Bank of St Louis (United States)
Sarah Zubairy - Texas A and M University (United States)
Abstract: The Euro-area poses a unique problem in evaluating counter-cyclical 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, respond to area-wide conditions but fiscal policy responds only to country-level conditions. We find that there is broad variation in different countries' responses to area-wide monetary policy and 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.