The impact of public consumption and investment in the euro area during periods of high and normal uncertainty

The new millennium featured several periods of high uncertainty in which fiscal policy responded as expansionary. The literature focuses heavily on the United States and does not distinguish between different effects of public consumption and investment. We estimate multipliers for both government spending components using local projections and quarterly panel data from 1999 to 2019 for the euro area countries. In times of high economic uncertainty, an increase in public consumption or investment of one euro increases GDP by about one and two euros, but only 0.4 euros in normal episodes. The larger output effect of public consumption during uncertain periods results from additional employment and increased labor income because of higher real wages which raise inflation. Government investment substantially increases GDP through productivity improvements that are partly transferred to workers via higher wages. Due to the positive supply effect, government investment, unlike consumption, is not inflationary. •Economic uncertainty determines the size of government spending multipliers.•Public investment multipliers during periods of high uncertainty are close to 2.•Public consumption multipliers during periods of high uncertainty are near 1.•Public consumption is inflationary and government investment is deflationary.•Public consumption reduces the unemployment rate and increases real wages.