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The Portuguese Public Finances and the Spanish Horse

Author

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  • António Portugal Duarte
  • João Sousa Andrade

Abstract

Two theses are presented and discussed throughout the paper. First, the limits on public deficits with the Stability and Growth Pact (SGP) do not correspond to the imposition of restrictive fiscal policies, but instead to the abandonment of an ultimate goal of economic policy: full employment. We claim that the Maastricht SGP design represents a truly rupture with fiscal policy approach in the post-war period and not just more discipline. Second, the simple choice for output trends, based on Hodrick-Prescott or production function, leads to an incorrect concept of potential output. We argue that fiscal policies tend to exacerbate the negative gaps if the potential output is assimilated to the output trend when used in fiscal policy. A few years of sluggish economic growth is just what is needed to generate that outcome.A new methodology for both output trend and gaps is applied and cyclically adjusted budget balance are calculated for the Portuguese economy. Methodology: Hodrick-Prescott filterThe goal of full employment is no longer present in the idea of zero public balances in the medium-term when the reference for long-run output is a concept of trend GDP. In the medium-term, the cycles will offset each other when calculated in relation to a trend and thus the same applies to the budget balances as defined in the SGP. We used the metaphor of the “Spanish Horse” to emphasize the fact that if actual output moves away persistently from full employment output, trend output will also move away from full employment output. As a consequence, expenditures will tend to increase and revenues to decrease. This situation creates deficits that should be corrected by the SGP. This correction will lead to a reduction in demand and thus of actual output and therefore, necessarily, in trend output itself. This will in turn bring the economy back to the problem of an excessive deficit. The horse will become accustomed to eat nothing, little by little. We have presented a solution to this problem based on the concept of trend output in order to empirically correct its inflection after 2002. The correction proposed reconciles, in a certain sense, the concept of trend output with the “old concept” of potential output. Based on this newly constructed output series, we calculated the values of the budget deficit adjusted for the output gap. We show evidence that the policy pursued during recent years is far from being expansionist. On the contrary, it is very restrictive contributing to moving actual output away from its full employment value.

Suggested Citation

  • António Portugal Duarte & João Sousa Andrade, 2012. "The Portuguese Public Finances and the Spanish Horse," EcoMod2012 3718, EcoMod.
  • Handle: RePEc:ekd:002672:3718
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    References listed on IDEAS

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    Cited by:

    1. João Sousa Andrade & António Portugal Duarte, 2012. "The Importance of a Good Indicator for Global Exciess Demand," Book Chapters, Institute of Economic Sciences.

    More about this item

    Keywords

    Portugal; Public finance; Tax policy;

    JEL classification:

    • C01 - Mathematical and Quantitative Methods - - General - - - Econometrics
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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