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Estimating simple fiscal policy reaction functions for the euro area countries

  • Martin Plödt
  • Claire Reicher

We formulate and estimate a simple fiscal policy reaction function for the euro area and individual euro area countries. Our reaction function allows for primary surpluses to feature three components: an anti-cyclical response of primary surpluses to the output gap, a response to the debt-GDP ratio, and an exogenous fiscal policy shifter. In line with the cyclical adjustment literature and in contrast with much of the previous time-series literature, we find a consistently strong anti-cyclical response of primary surpluses to the output gap for the euro area. We also find a consistently strong positive response of primary surpluses to the debt-GDP ratio. Our estimates are robust to different output gap measures and to different assumptions regarding the order of integration of observables. In addition, we provide statistical evidence in favor of our specification of a fiscal policy reaction function which features persistent fiscal policy shocks as opposed to an alternative specification found in the literature which features fiscal policy smoothing. Altogether, our results help to reconcile widely differing estimates from the literature, and we argue that our results may therefore provide guidance to forecasters and policymakers

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Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1899.

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Length: 27 pages
Date of creation: Jan 2014
Date of revision:
Handle: RePEc:kie:kieliw:1899
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  1. Marcellino, Massimiliano & Musso, Alberto, 2010. "The Reliability of Real Time Estimates of the Euro Area Output Gap," CEPR Discussion Papers 7716, C.E.P.R. Discussion Papers.
  2. Balázs Égert, 2014. "Fiscal policy reaction to the cycle in the OECD: pro- or counter-cyclical?," Mondes en développement, De Boeck Université, vol. 0(3), pages 35-52.
  3. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September.
  4. Bénétrix, Agustín S. & Lane, Philip R., 2013. "Fiscal cyclicality and EMU," Journal of International Money and Finance, Elsevier, vol. 34(C), pages 164-176.
  5. Amemiya, Takeshi, 1974. "The nonlinear two-stage least-squares estimator," Journal of Econometrics, Elsevier, vol. 2(2), pages 105-110, July.
  6. Henning Bohn, . "Budget Balance Through Revenue or Spending Adjustments ? Some Historical Evidence for the United States (Reprint 013)," Rodney L. White Center for Financial Research Working Papers 03-91, Wharton School Rodney L. White Center for Financial Research.
  7. Christopher Reicher, 2011. "An Estimated Fiscal Taylor Rule for the Postwar United States," Kiel Working Papers 1705, Kiel Institute for the World Economy.
  8. John B. Taylor, 2000. "Reassessing Discretionary Fiscal Policy," Journal of Economic Perspectives, American Economic Association, vol. 14(3), pages 21-36, Summer.
  9. Henning Bohn, . "Budget Balance Through Revenue or Spending Adjustments? Some Historical Evidence for the United States," Rodney L. White Center for Financial Research Working Papers 28-89, Wharton School Rodney L. White Center for Financial Research.
  10. Afonso, António & Hauptmeier, Sebastian, 2009. "Fiscal behaviour in the European Union: rules, fiscal decentralization and government indebtedness," Working Paper Series 1054, European Central Bank.
  11. Plödt, Martin & Reicher, Claire, 2014. "Primary surplus and debt projections based on estimated fiscal reaction functions for euro area countries," Kiel Working Papers 1900, Kiel Institute for the World Economy (IfW).
  12. Roberto Golinelli & Sandro Momigliano, 2009. "The Cyclical Reaction of Fiscal Policies in the Euro Area: The Role of Modelling Choices and Data Vintages," Fiscal Studies, Institute for Fiscal Studies, vol. 30(1), pages 39-72, 03.
  13. Reicher, Christopher Phillip, 2011. "An estimated fiscal Taylor rule for the postwar United States," Kiel Working Papers 1705, Kiel Institute for the World Economy (IfW).
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