Effects of Fiscal Policy Shocks in the Euro Area Lessons Learned from Fiscal Consolidation

European Union member countries are currently exposed to negative implications of the economic and debt crisis Questions associated with disputable implications of fiscal incentives seem to be contrary to the crucial need of the effective fiscal consolidation that is necessary to reduce excessive fiscal deficits and high sovereign debts While challenges addressed to the fiscal policy and its anti cyclical potential rose steadily but not desperately since the beginning of the economic crisis the call for fiscal consolidation became urgent almost immediately and this need significantly strengthen after the debt crisis contagion flooded Europe In the paper we provide an overview of main trends in public budgets and sovereign debts in the Euro Area member countries during last two decades We identify episodes of successful and unsuccessful cold showers versus gradual fiscal expenditure versus revenue based consolidations by analyzing effects of improvements in cyclically adjusted primary balance on the sovereign debt ratio reduction We also estimate VAR model to analyze effects of fiscal shocks based on one standard deviation in total expenditure direct and indirect taxes to real output It is expected that responses of real output to different types of consolidating fiscal shocks may vary and thus provide more precise ideas about a feasibility i e side effects on the macroeconomic performance of expenditure versus revenue based fiscal consolidation episodes Economic effects of fiscal consolidating adjustments are evaluated for two periods pre crisis and extended to reveal crisis effects on fiscal consolidation efforts