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The tradeoff between efficiency and macroeconomic stabilization in Europe

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Author Info

  • Carlos Martinez-Mongay
  • Khalid Sekkat

Abstract

The paper contributes to the debate on the stability/efficiency tradeoff of automatic stabilizers. A simple AD-AS two countries model is presented and illustrates circumstances where a reduction in taxes can foster stabilization. The testable implication from the model is that tax cuts can either increase or decrease volatility depending on the structure of the taxation system. Hence, lowering taxes for efficiency purposes may not cost in terms of stabilization. This implication is tested on a sample of 25 OECD countries over the period 1960-1999 taking account of the endogeneity and omitted variables issues identified in the literature. We found acceptably robust evidence that the size of governments in OECD countries has played a stabilizing role for both output and inflation. However, the relationship between government size and macroeconomic stability is not linear. The composition of public finances, in particular the tax mix, matters for output and price volatility. Distorting taxes, namely taxes on labor and capital, might have negative effects on macroeconomic stability. Consequently, the potential trade off between stability and flexibility might not exist.

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Bibliographic Info

Paper provided by ULB -- Universite Libre de Bruxelles in its series Working Papers CEB with number 04-024.RS.

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Length: 32 p.
Date of creation: May 2003
Date of revision:
Publication status: Published by: Centre Emile Bernheim, Bruxelles
Handle: RePEc:sol:wpaper:04-024

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Keywords: Automatic stabilizers; efficiency; Europe.;

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References

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  1. Persson, T. & Tabellini, G., 1998. "The Size and Scope of Government: Comparative Politics with Rational Politicians," Papers 658, Stockholm - International Economic Studies.
  2. Mendoza, Enrique G. & Milesi-Ferretti, Gian Maria & Asea, Patrick, 1997. "On the ineffectiveness of tax policy in altering long-run growth: Harberger's superneutrality conjecture," Journal of Public Economics, Elsevier, vol. 66(1), pages 99-126, October.
  3. Buti, Marco & Sapir, André, 2001. "EMU in the Early Years: Differences and Credibility," CEPR Discussion Papers 2832, C.E.P.R. Discussion Papers.
  4. André Sapir & Marco Buti, 1998. "Economic policy in EMU," ULB Institutional Repository 2013/8078, ULB -- Universite Libre de Bruxelles.
  5. T. Biebuyck & Ariane Chapelle & Ariane Szafarz, 2005. "Les leviers de contrôle des actionnaires majoritaires," DULBEA Working Papers in, ULB -- Universite Libre de Bruxelles.
  6. Fatás, Antonio & Mihov, Ilian, 1999. "Government Size and Automatic Stabilizers: International and Intranational Evidence," CEPR Discussion Papers 2259, C.E.P.R. Discussion Papers.
  7. Sapir, Andre & Sekkat, Khalid, 2002. " Political Cycles, Fiscal Deficits, and Output Spillovers in Europe," Public Choice, Springer, vol. 111(1-2), pages 195-205, March.
  8. Khalid Sekkat & Marco Buti & Carlos Martinez-Mongay & Paul van den Noord, 2003. "Macroeconomic policy and structural reform: a conflict between stabilisation and flexibility?," ULB Institutional Repository 2013/7388, ULB -- Universite Libre de Bruxelles.
  9. Ariane Chapelle & Ariane Szafarz, 2005. "Controlling firms through the majority voting rule," ULB Institutional Repository 2013/149192, ULB -- Universite Libre de Bruxelles.
  10. Daveri, Francesco & Tabellini, Guido, 1997. "Unemployment, Growth and Taxation in Industrial Countries," CEPR Discussion Papers 1681, C.E.P.R. Discussion Papers.
  11. Gannon, Brenda & Plasman, Robert & Rycx, Francois & Tojerow, Ilan, 2005. "Inter-Industry Wage Differentials and the Gender Wage Gap: Evidence from European Countries," IZA Discussion Papers 1563, Institute for the Study of Labor (IZA).
  12. Carlos Martinez-Mongay & Khalid Sekkat, 2003. "The tradeoff between efficiency and macroeconomic stabilization in Europe," Working Papers CEB 04-024.RS, ULB -- Universite Libre de Bruxelles.
  13. Thierry Lallemand & Robert Plasman & François Rycx, 2007. "The establishment-size wage premium: evidence from European countries," ULB Institutional Repository 2013/8735, ULB -- Universite Libre de Bruxelles.
  14. Khalid Sekkat & Marie-Ange Veganzones, 2005. "Trade and foreign exchange liberalization, investment climate and FDI in the MENA," DULBEA Working Papers 05-06.RS, ULB -- Universite Libre de Bruxelles.
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