ECB RESEARCH: Hiking Government Spending Does Little For Economies

Full paper here: The Macroeconomic Effects of Fiscal Policy

FRANKFURT, Jan 12 (Reuters) – Hiking government spending does little for economies, has a minimal impact on consumer spending, hits stock prices and can put off private investment, new European Central Bank research shows.

‘Shocks’ — or changes — in government spending also lead to a depreciation of the real effective exchange rate and have a mixed impact on house prices according to the ECB working paper, entitled ‘The Macroeconomic Effects of Fiscal Policy’.

The paper comes as several European countries draw up plans for massive extra stimulus packages to kick-start troubled economies on top of a 200 billion euro ($267.8 billion) Europe-wide package already agreed by leaders.

The ECB says working papers do not necessarily reflect the views of the central bank but based on data from the United States, Britain, Germany and Italy the paper’s authors, Antonio Afonso and Ricardo Sousa, listed a string of drawbacks from government spending swings.

‘The empirical evidence suggests that government spending shocks have, in general, a small effect on GDP,’ and ‘can have a ‘have a negative effect on private investment,’ they wrote.

Changes in spending also had, ‘little impact on private consumption and can have a varied effect on housing prices, lead to a quick fall in stock prices… lead to a depreciation of the real effective exchange rate.’

Germany is expected to sketch out plans for up to 50 billion euros in extra spending measures and tax cuts later on Monday in its latest move to combat the financial crisis.

ECB President Jean-Claude Trichet has warned that euro zone countries should think carefully about how much debt they pile on to help boost their economies and the working paper confirmed the need for caution.

‘While government spending shocks do not seem to have an impact on private consumption, the effects on private investment are rather negative, supporting the idea of a ‘crowding-out’ effect,’ the paper said.

Going into more depth on exchange rates it said that in the case of the UK, a government spending shock would, on average, cause the real effective exchange rate to depreciate persistently for almost 20 quarters, with similar results foreseen in the United States.

European laws are designed to stop countries building up too much debt. EU stability and growth pact rules state that national governments should have a balanced budget over the medium term, and not exceed a budget deficit of 3 percent of gross domestic product.

However the wording of the pact provides some wiggle-room for nations and with economies across Europe now firmly in recession governments are looking to exploit the room for manoeuvre.

On a more positive note the ECB research said that spending changes tend to have a ‘positive and persistent impact on productivity,’ and that in contrast to spending, increases in government revenues appeared to boost economies.

It said revenue ‘shocks’ tended to have ‘positive effects on GDP and private investment, have a positive effect on both housing prices and stock prices… and lead to an appreciation of the real effective exchange rate.’

01.12.09, 06:42 AM EST

Source: Forbes

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