ECB Paper Finds Timing Matters in Fiscal Spree by Indebted State
For a government with a lot of debt, timing is everything when it comes to embarking on a fiscal splurge, according to research by the European Central Bank.
Interest rates at the effective lower bound can enhance the impact of a public-spending shock on the economy and largely mute debt-sustainability concerns, Niccolo Battistini and Giovanni Callegari wrote in a research bulletin published Friday. Still, governments are well-advised not to wait too long.
An “excessively delayed” response that continues into a period when monetary policy may have to react to inflation pressures “would not benefit from the large fiscal multipliers” of rock-bottom interest rates, the authors said. “In contrast, a delayed fiscal expansion could lead to soaring sovereign spreads and debt levels and, eventually, long-run output losses.”
“As these dynamics would be further amplified in the presence of higher initial debt levels, the right timing for a fiscal expansion is crucial, especially for highly indebted countries,” they wrote.
The publication coincides with a growing push from the ECB to encourage governments in Germany and the Netherlands, where public debts are low, to loosen purse strings and help boost the economy. Countries like Italy, with massive piles of borrowing, have mostly been encouraged to get their fiscal house in order first.
The researchers caution that their results don’t necessarily apply to the euro area. In a currency union, strategic behavior by individual member states also plays a part, especially regarding the possible incentive to “free ride” on the safety premium of countries with better fundamentals.
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