Consumption Smoothing Through Fiscal Policy in OECD and EU Countries

We measure the amount of smoothing achieved through various components of the government deficit in EU and OECD countries. For EU countries, at the 1-year frequency, 13 percent of shocks to GDP are smoothed via government consumption, 18 percent via transfers, 5 percent via subsidies, while taxes provide no smoothing. The results for OECD countries are similar. Government transfers provide more smoothing of negative than of positive shocks among EU countries. There seems to be no tradeoff between high government deficits in a country and the ability to smooth consumption. We find that in countries where there is "delegation" of power or where fiscal targets are negotiated effectively by coalition members, consumption smoothing via government consumption and government transfers is considerably higher. We interpret this finding as evidence that effective budgetary institutions can accomplish efficient consumption smoothing via government deficit spending and lower average deficits.