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Fiscal Policy Stance in the European Union: The Impact of the Euro

Listed author(s):
  • Mencinger, Jernej
  • Aristovnik, Aleksander

In the recent years there has been an intense discussion whether the actual behaviour of fiscal authorities is consistent with cyclical stabilization objectives. The question of the appropriate fiscal policy is gaining recognition especially for the countries of the euro area after entering the European Monetary Union (EMU). Therefore, the aim of this paper is to evaluate the activity of the fiscal policy before and after the entrance to the euro zone for each individual EMU country in 1995–2010 period. For this purpose we will use the cyclical adjusted balance, which is the common tool used to estimate fiscal policy stance. The analysis of the cyclically adjusted balance gives an additional insight into the former activity arrangements of the fiscal policy, which contributes to gauge the ex-post estimation of the fiscal policy. On this base we can determine the causes of general government budgets imbalance in the past. Despite this fact, we should be aware of some caveats in the assessment of cyclical adjusted balance, which appear due the inconsistency in measurement of output gap and potential GDP growth. To evaluate pro-cyclical or countercyclical fiscal policy stance we compare the dynamic evaluation of the cyclically adjusted balance and output gap. Namely, changes of the cyclically adjusted balance in consecutive years indicate the orientation of fiscal policy, i.e. the fiscal impulse. By comparing the change in the cyclically adjusted balance and output gap between individual years, which indicates fluctuations in the economic cycle, it is possible to assess the orientation of fiscal policy, i.e. the fiscal position. The fiscal policy can be considered as countercyclical if it is expansive in the situation of negative output gap and restrictive in the situation, when the actual growth of GDP is above its potential rate. On the other hand, fiscal policy is characterized to be pro-cyclical if in the situation of negative output gap the government uses restrictive fiscal instruments and when the fiscal policy reacts expansionary in the situation of positive output gap, where the actual output exceeds the estimated potential GDP. In the empirical analysis we evaluate the fiscal policy stance for each country of the euro area. In the assessment of government behaviour we cover 14 countries in the 1995–2010 period. The results of the analysis generally confirm that the fiscal policy in most euro-area member states became more expansionary in the period after entering the EMU. Moreover, these preliminary findings were partly confirmed by a statistical analysis which shows statistically significant differences in expansionary fiscal policy between the aforementioned sub-periods. In addition, we might also conclude the average fiscal stance is expansionary when actual output is above its potential level, which implies a pro-cyclical bias in times of prosperity, and that the fiscal stance tends to be predominantly counter-cyclical when actual output is below its potential level. These conclusions can be associated with asymmetric fiscal behaviour after entering the euro area because the response of fiscal authorities to cyclical conditions in the economy depends on whether good or bad times are prevailing. These assertions reflect some conclusions made in other similar studies.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 44708.

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Date of creation: Feb 2013
Publication status: Published in Engineering Economics 1.24(2013): pp. 52-62
Handle: RePEc:pra:mprapa:44708
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  1. Alberto Alesina & Filipe R. Campante & Guido Tabellini, 2008. "Why is Fiscal Policy Often Procyclical?," Journal of the European Economic Association, MIT Press, vol. 6(5), pages 1006-1036, September.
  2. Marco Buti & Paul Noord, 2004. "Fiscal Discretion and Elections in the Early Years of EMU," Journal of Common Market Studies, Wiley Blackwell, vol. 42(4), pages 737-756, November.
  3. Charles Wyplosz, 2006. "European Monetary Union: the dark sides of a major success," Economic Policy, CEPR;CES;MSH, vol. 21(46), pages 207-261, April.
  4. Jacopo Cimadomo, 2005. "Has the Stability and Growth Pact Made Fiscal Policy More Pro-Cyclical?," La Lettre du CEPII, CEPII research center, issue 247.
  5. Holm-Hadulla, Fédéric & Hauptmeier, Sebastian & Rother, Philipp, 2010. "The impact of numerical expenditure rules on budgetary discipline over the cycle," Working Paper Series 1169, European Central Bank.
  6. Hauptmeier, Sebastian & Sanchez-Fuentes, A. Jesus & Schuknecht, Ludger, 2011. "Towards expenditure rules and fiscal sanity in the euro area," Journal of Policy Modeling, Elsevier, vol. 33(4), pages 597-617, July.
  7. Carlos Marinheiro, 2005. "Has the Stability and Growth Pact stabilised? Evidence from a panel of 12 European countries and some implications for the reform of the Pact," GEMF Working Papers 2005-02, GEMF, Faculty of Economics, University of Coimbra.
  8. Roberto Golinelli & Sandro Momigliano, 2008. "The cyclical response of fiscal policies in the euro area. Why do results of empirical research differ so strongly?," Temi di discussione (Economic working papers) 654, Bank of Italy, Economic Research and International Relations Area.
  9. Golinelli, Roberto & Momigliano, Sandro, 2006. "Real-time determinants of fiscal policies in the euro area," Journal of Policy Modeling, Elsevier, vol. 28(9), pages 943-964, December.
  10. Alessandro Turrini, 2008. "Fiscal policy and the cycle in the Euro Area: The role of government revenue and expenditure," European Economy - Economic Papers 2008 - 2015 323, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission.
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