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Prepared by James John and Tao Wu with assistance from Jesse Siminitz (all EUR), and in collaboration with Benjamin Hunt and Susanna Mursula (both RES). We appreciate helpful comments from euro area country teams in EUR, and counterparts at the European Commission and ECB.
There is a large literature suggesting that fiscal multiplier tends to be considerably higher in or near a liquidity trap than in normal times, for instance, Eggertsson (2008); Christiano, Eichenbaum, and Rebelo (2011); Woodford (2011), and Belinga and Ngouana (2015).
For more detail, see Andrle, Michal et al, “The Flexible System of Global Models,” IMF Working Paper (WP/15/64), March 2015.
For Spain, the April 2016 WEO baseline projections do not include the higher-than-expected fiscal deficit in 2015 of 5.1 percent of GDP, implying upward revisions to the path of the fiscal deficit and public debt under current policies.
The interest rate assumptions are in line with market expectations as reflected in the EONIA forward curve while the asset purchase assumption is consistent the ECB Governing Council’s forward guidance, whereby asset purchases of €80 billion per month are expected to continue through the end of March 2017 or until there is a sustained adjustment in the path of inflation consistent with the Governing Council’s price stability objective.
For illustrative purposes, apart from Italy, use of SGP flexibility is assumed for all five of the non-EDP countries covered in EUROMOD, although in practice some of these countries might not meet all of the criteria specified by the European Commission.
The corporate borrowing cost reduction figures are calibrated based on the elasticity of changes in credit risk premiums in each euro area country between August 2014 and June 2015 to the observed write-off rates during the same time period (coinciding with the sample cut-off date of data obtained from the 2015 EBA Transparency Exercise).
The analysis assumes two years before structural reforms are implemented. If, due to political or other factors, it took longer to implement reforms or if they were not fully implemented, the impact would be smaller.
Specifically, for 2017–21, investment would be ¼ percentage point lower each year, sovereign and corporate risk premia in high-debt countries (Greece, Ireland, Italy, Portugal, and Spain) would be 75 basis points higher, and the total factor productivity growth rate would be 0.1 percentage point lower each year.
For further discussion of a stagnation scenario, please see: Lin, Huidan, “Risks of Stagnation in the Euro Area,” January 2016, IMF Working Paper WP/16/9.