On the usefulness of government spending in the EU area

We investigate the effects of fiscal policy on private consumption and investment in the European Union. A certain consensus has aroused that fiscal impulses have expansionary Keynesian effects on the economic activity. However, the existing empirical literature has concentrated on few countries, mostly outside the EU. We check the validity of this result for the EU area, by using annual data and a panel vector auto-regression approach (PVAR). Our results show that increases in public spending lead to positive and significant effects on private consumption and private investment. According to our baseline estimate, a 1% increase in public spending produces a 0.26% on impact rise in private consumption, and a 0.43% impact rise in private investment. The effects are substantial, and die out slowly in the case of private consumption (0.63% cumulative impact after 3 years), but much faster in the case of private investment. A further disaggregation between wage and non-wage components reveals that public salaries have a relatively stronger stimulating role, a result which is probably due to the importance of the public sector especially in continental Europe. Note that this is not due to the different weight on GDP of the two components, which have comparable values in our sample.