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Fiscal policy in Europe: The importance of making it predictable

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  • Cavallari, Lilia
  • Romano, Simone

Abstract

This paper provides evidence in support of the hypothesis that fiscal policy is largely anticipated and its effects depend on the extent to which policy is able to affect expectations. Based on a set of 2-country Bayesian VAR models between major European economies, we find that a surprise stimulus triggers expectations of deficit reversals that may crowd out private expenditure. An anticipated stimulus, on the contrary, is found to boost domestic activity in all samples. Moreover, it has positive cross-border effects in 50 percent of the cases. Overall, our findings suggest that fiscal policy is effective when it is not “crowded out” by expectations of reversals. We document such crowding out effects in Italy and France. Finally, we argue that predictability has important consequences for the design of discretionary policy.

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  • Cavallari, Lilia & Romano, Simone, 2017. "Fiscal policy in Europe: The importance of making it predictable," Economic Modelling, Elsevier, vol. 60(C), pages 81-97.
  • Handle: RePEc:eee:ecmode:v:60:y:2017:i:c:p:81-97
    DOI: 10.1016/j.econmod.2016.09.008
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    8. Daniela Fantozzi & Alessio Muscarnera, 2021. "A News-based Policy Index for Italy: Expectations and Fiscal Policy," CEIS Research Paper 509, Tor Vergata University, CEIS, revised 11 Mar 2021.
    9. António Afonso & José Alves & João Tovar Jalles, 2021. "(Non-) Keynesian Effects of Fiscal Austerity: New Evidence from a large sample," Working Papers REM 2021/0158, ISEG - Lisbon School of Economics and Management, REM, Universidade de Lisboa.
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    13. Jamel JOUINI, 2018. "Measuring the Macroeconomic Impacts of Fiscal Policy Shocks in the Saudi Economy : A Markov Switching Approach," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(4), pages 55-70, December.
    14. Pietro Dallari & Antonio Ribba, 2019. "The Dynamic Effects of Monetary Policy and Government Spending Shocks on Unemployment in the Peripheral Euro Area Countries," Department of Economics 0143, University of Modena and Reggio E., Faculty of Economics "Marco Biagi".
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    More about this item

    Keywords

    Fiscal policy; VAR model; Fiscal spillovers; Fiscal multiplier;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • F45 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Macroeconomic Issues of Monetary Unions
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus

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