Chapter 1 . Estimating the Effects of Government Spending in the Euro Area ∗ Joo

This paper investigates the effects of government spending in the Euro area where the fixed exchange rate regimes have been maintained. I employ the Bayesian pooling method which has been used to analyze the effect of monetary policy. By applying the Bayesian estimation procedure to the panel of VARs in the Euro area, I explore whether there exists heterogeneity in country dynamics or not, i.e., whether country’s coefficients are similar or not. Unlike the country-by-country estimation (or no pooling), Bayesian pooling alleviates a small sample problem by reducing the effective number of parameters to be estimated. Compared to the panel of VARs (or full pooling), Bayesian pooling displays better fit. Two sub group Bayesian pooling reveals that country dynamics are heterogeneous in terms of private consumption, net exports and the real exchange rate. This estimation result suggests that there exist heterogeneous transmission mechanisms across countries in response to a government spending shock.