A time-varying approach to assessing fiscal cyclicality: The impact of the European fiscal framework

This paper offers new empirical insights into the relationship between the European fiscal framework and the cyclical stance of fiscal policy in EMU countries. By employing a Time-Varying Coefficient (TVC) model, we generate country- and year-specific measures of fiscal cyclicality from 1995 to 2019. We then quantify the evolving intensity of fiscal rules through a country- and year-specific composite index and assess its impact on fiscal cyclicality via panel regressions with multiple estimators, including a robust IV-GMM specification that addresses endogeneity concerns. This dual-framework strategy enables us to capture the distortion introduced by real-time revisions and identify a significant pro-cyclical bias in peripheral countries, which is largely masked when expost data are used. In other words, our findings reveal a marked asymmetry: while the effect of fiscal rules on cyclicality is neutral or mildly counter-cyclical in core countries, it is significantly pro-cyclical in peripheral ones when real-time data are considered. These results have important implications for the revised European fiscal framework, as the new indicator – net expenditure – continues to rely on cycle-sensitive variables and therefore risk perpetuating the same structural biases. Our analysis calls for a deeper reconsideration of the methodology used to estimate potential output in the EU. By demonstrating how the interaction between fiscal rules and real-time macroeconomic estimates can generate unintended policy outcomes, this study contributes to a more informed debate on the future of fiscal governance in the euro area.