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The Portuguese Public Finances and the Spanish Horse

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  • João Sousa Andrade

    (Faculty of Economics University of Coimbra and GEMF)

  • António Portugal Duarte

    (Faculty of Economics University of Coimbra and GEMF)

Abstract

This study is based on the idea that inadequate use of fiscal policy through restrictive policies shifts the short-run demand curve that in turn induces shifts in the long-run supply curve leading to a dynamic reduction of growth. The analogy with the old metaphor of the Spanish horse seems obvious. We apply this idea to Portugal to 2002-2009, we will prove that in order not to be caught in the horse’s trap we have to keep the concept of potential output in the evaluation of the structural budget balance instead of replacing it by a trend indicator, which, can lead to a sustainable reduction of the “food” and consequently to a disaster. The goal of full employment is no longer present in the idea of zero public balances. In the medium-term, the cycles will offset each other when calculated in relation to a trend and thus the same applies to budget balances as defined in the Stability and Growth Pact (SGP). If actual output moves away persistently from full employment output, trend output will also move away from full employment. As a consequence, expenditures will tend to increase and incomes to decrease. This situation creates deficits that should be corrected by the SGP. This correction will lead to a reduction in demand and thus in actual output and therefore, necessarily, in trend output itself. We present an empirical solution to this problem based on the concept of trend output in order to correct its inflection after 2002. This analysis has two drawbacks, the influence of deficits in the prices of non-tradable goods and the fact that we may not have food to give to our horse. This is the case if public debt is too high. Nevertheless, this study shows that the criteria and methods that are used by the SGP in the definition of fiscal policy are incorrect.

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Bibliographic Info

Paper provided by GEMF - Faculdade de Economia, Universidade de Coimbra in its series GEMF Working Papers with number 2011-21.

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Length: 33 pages
Date of creation: Dec 2011
Date of revision:
Publication status: Published in Économie Appliquée LXVI(4): 5-26, 2013.
Handle: RePEc:gmf:wpaper:2011-21

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Related research

Keywords: Budget deficit; cyclically adjusted budget balance; fiscal policy; Hodrick-Prescott filter and output gap.;

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References

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Cited by:
  1. João Sousa Andrade & António Portugal Duarte, 2012. "The Importance of a Good Indicator for Global Exciess Demand," Book Chapters, Institute of Economic Sciences.

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