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The tradeoff between efficiency and macroeconomic stabilization in Europe

  • Carlos Martinez-Mongay
  • Khalid Sekkat

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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File URL: https://dipot.ulb.ac.be/dspace/bitstream/2013/7448/1/ks-0076.pdf
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Paper provided by ULB -- Universite Libre de Bruxelles in its series DULBEA Working Papers with number 05-04.RS.

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Length: 34 p.
Date of creation: Feb 2005
Date of revision:
Publication status: Published by: DULBEA - Université libre de Bruxelles, Bruxelles
Handle: RePEc:dul:wpaper:05-04rs
Contact details of provider: Web page: http://difusion.ulb.ac.be

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  1. André Sapir & Marco Buti, 1998. "Economic policy in EMU," ULB Institutional Repository 2013/8078, ULB -- Universite Libre de Bruxelles.
  2. Brenda Gannon & Robert Plasman & François Rycx & Ilan Tojerow, 2005. "Inter-industry wage differentials and the gender wage gap: evidence from European countries," DULBEA Working Papers 05-01.RS, ULB -- Universite Libre de Bruxelles.
  3. Persson, Torsten & Tabellini, Guido, 1999. "The size and scope of government:: Comparative politics with rational politicians," European Economic Review, Elsevier, vol. 43(4-6), pages 699-735, April.
  4. 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.
  5. 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.
  6. Thierry Lallemand & Robert Plasman & François Rycx, 2007. "The establishment-size wage premium: evidence from European countries," Empirica, Springer, vol. 34(5), pages 427-451, December.
  7. Hairault, Jean-Olivier & Langot, Francois & Portier, Franck, 2001. "Efficiency and stabilization: reducing Harberger triangles and Okun gaps," Economics Letters, Elsevier, vol. 70(2), pages 209-214, February.
  8. Ariane Chapelle & Ariane Szafarz, 2005. "Controlling firms through the majority voting rule," ULB Institutional Repository 2013/149192, ULB -- Universite Libre de Bruxelles.
  9. Francesco Daveri & Guido Tabellini, . "Unemployment, Growth and Taxation in Industrial Countries," Working Papers 122, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  10. Dani Rodrik, 1996. "Why Do More Open Economies Have Bigger Governments?," NBER Working Papers 5537, National Bureau of Economic Research, Inc.
  11. Marco Buti & André Sapir, 2002. "EMU in the Early Years: Differences and Credibility," Chapters, in: EMU and Economic Policy in Europe, chapter 1 Edward Elgar.
  12. Fatas, Antonio & Mihov, Ilian, 2001. "Government size and automatic stabilizers: international and intranational evidence," Journal of International Economics, Elsevier, vol. 55(1), pages 3-28, October.
  13. Fatás, Antonio & Mihov, Ilian, 2002. "The Case for Restricting Fiscal Policy Discretion," CEPR Discussion Papers 3277, C.E.P.R. Discussion Papers.
  14. 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.
  15. T. Biebuyck & Ariane Chapelle & Ariane Szafarz, 2005. "Les leviers de contrôle des actionnaires majoritaires," ULB Institutional Repository 2013/719, ULB -- Universite Libre de Bruxelles.
  16. André Sapir & Khalid Sekkat, 2002. "Political cycles, fiscal deficits and output spillovers in Europe," ULB Institutional Repository 2013/7346, ULB -- Universite Libre de Bruxelles.
  17. 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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