Asset price volatility and government revenue

This paper investigates the effect of commercial, residential property and equity price volatility on the variability of cyclically adjusted government revenue. We find significant evidence that asset price volatility increases the variability of government revenue. A 1% increase in equity price volatility increases government revenue variability by 0.37–0.44%. An increase in residential property price volatility increases revenue volatility by about 0.15–0.22%, whereas this effect diminishes to 0.11% in case of commercial property price. This evidence reflects the automatic increase of government revenue variability due to asset price movements and supports arguments in favour of adjusting fiscal variables for both business cycle and asset price changes. However, we also find evidence that equity price variability increases revenue variability even when government revenue is adjusted for both economic and asset price cycles, indicating the presence of more complicated dynamics between fiscal variables and asset price changes.     

Fiscal policy and asset price volatility

This paper investigates the relationship between volatility of different asset prices and the volatility of various indicators of fiscal policy (primary balance, spending and revenue). We find evidence that asset price volatility affects the volatility of fiscal policy stance in a positive and significant way. The effect comes primarily through residential property and equity price volatility on government revenue and spending. Increased volatility in commercial property prices is associated with increased variability of government revenue. Output growth volatility is the dominant determinant of revenue and primary balance variability, whereas bad budgetary conditions and the size of the public sector are the most significant determinants of spending variability. Trade openness leads to greater variability of government spending, revenue and primary balance to GDP ratios.     

Fiscal stabilizations: When do they work and why

This paper studies the determinants and channels through which fiscal contractions influence the dynamics of the debt-to-GDP ratio and GDP growth. Using data from a panel of OECD countries, the paper shows that the success of fiscal adjustments in decreasing the debt-to-GDP ratio depends on the size of the fiscal contraction and less on its composition. The rate of growth of output matters too, but higher GDP growth does not drive the success of a fiscal stabilization. In contrast, whether a fiscal adjustment is expansionary depends largely on the composition of the fiscal maneuvre. In particular, stabilizations implemented by cutting public spending lead to higher GDP growth rates. The effects of the composition on growth work mostly through the labor market rather than through agents’ expectations of future fiscal policy. Finally, the evidence suggests that successful and expansionary fiscal contractions are not the result of accompanying expansionary monetary policy or exchange rate devaluations.     

FISCAL POLICY AND ASSET PRICES

We analyse the impact of fiscal policy on asset prices using a panel vector auto‐regressive (PVAR) approach and quarterly data for ten industrialized countries. We find that positive fiscal shocks lead to a temporary fall in stock prices and a gradual and persistent decrease in housing prices. The empirical findings also point to: (i) a contractionary effect of fiscal policy on output in line with the existence of crowding‐out effects and the deterioration of credit conditions; (ii) a weakening of the effectiveness of fiscal policy in recent times; (iii) a more persistent response of asset prices for countries with a lower degree of openness; (iv) a larger impact of fiscal policy on asset prices for small countries; (v) a close link between the responsiveness of asset prices to fiscal policy and the government’s size; (vi) an increase of the sensitivity of asset prices to fiscal policy shocks following the process of financial deregulation and mortgage liberalization; and (vii) significant fiscal multiplier effects in the context of severe housing busts. Finally, the evidence suggests that changes in equity prices may help governments towards consolidation of public finances.     

What are the effects of fiscal policy on asset markets?

We investigate the link between fiscal policy shocks and asset markets. Our results show that spending shocks have: a positive and persistent effect on GDP in the U.S. and in the U.K., while for Germany and Italy, such impact is temporary; a positive and persistent effect on housing prices; a negative effect on stock prices; and mixed effects on the price level. A VAR counter-factual exercise suggests that fiscal shocks play a minor role in the asset markets of the U.S. and Germany, and substantially increase the variability of housing and stock prices in the U.K., while government revenue shocks have increased volatility in Italy.     

Financial markets’ behavior around episodes of large changes in the fiscal stance

Using a panel of OECD countries from 1960 to 2002, this paper shows that interest rates, particularly those of long-term government bonds, decrease when countries’ fiscal position improves and increase around periods of budget deteriorations. Stock market prices surge around times of substantial fiscal tightening and plunge in periods of very loose fiscal policy. In addition, the paper shows that results depend on countries’ initial fiscal conditions and on the type of fiscal consolidations: Fiscal adjustments that occur in country-years with high levels of government deficit, that are implemented by cutting government spending, and that generate a permanent and substantial decrease in government debt are associated with larger reductions in interest rates and increases in stock market prices.     

Spending cuts or tax increases? The composition of fiscal adjustments as a signal

This paper shows that the composition of fiscal adjustments, spending cuts versus tax increases, serves as a signal of the government's degree of collusion with special interests. The politico-economic model of fiscal policies, combining retrospective voting with common-agency-type lobbying, presents undominated separating equilibria and intuitive pooling ones, in both of which fiscal adjustments with sufficiently large spending cuts lead to incumbent reappointment whereas those with only tax increases lead to incumbent defeat. These findings are consistent with the recent empirical evidence of voters behaving as fiscal conservatives. The efficiency-enhancing aspects of the signaling mechanism and the effects of imposing a deficit limit are also analyzed.     

Fiscal consolidations and electoral outcomes in emerging economies: Does the policy mix matter? Macro and micro level evidence from Latin America

Do voters punish governments that introduce fiscal “austerity” measures? If so, does voter response vary according to the composition of fiscal adjustments? The empirical literature on the political economy of fiscal adjustments, which is mostly OECD-based, argues that consolidations do not have significant electoral consequences. In contrast, we find that voters punish fiscal consolidations at the polls in Latin America. To explain this result, we focus on the way fiscal adjustments episodes are implemented, both in terms of their design (taxes vs. spending) and timing. Such episodes rely fundamentally on increasing tax rates and bases of indirect taxes (such as the VAT) that hit broad segments of the population. Moreover, these policies are often implemented when politicians have no choice but to consolidate, that is, under severe economic circumstances. These macro results are corroborated with micro evidence from an original survey experiment that measures voter’s fiscal policy preferences over the business cycle in seven countries across Latin America. The experimental evidence shows that respondents prefer expenditure cuts to tax increases during downturns, which is the opposite of the type of consolidations that countries typically pursue.     

Using time-varying transition probabilities in Markov switching processes to adjust US fiscal policy for asset prices

This paper tests for nonlinear effects of asset prices on the US fiscal policy. By modeling government spending and taxes as time-varying transition probability Markovian processes (TVPMS), we find that taxes significantly adjust in a nonlinear fashion to asset prices. In particular, taxes respond to housing and (to a smaller extent) to stock price changes during normal times. However, at periods characterized by high financial volatility, government taxation only counteracts stock market developments (and not the dynamics of the housing sector). As for government spending, it is neutral vis-a-vis the asset market cycles. We conclude that, correcting the fiscal balance and, notably, the revenue side for time-varying effects of asset prices provides a more accurate assessment of the fiscal stance and its sustainability.     

A Note on the (Un)Pleasant Arithmetic of Fiscal Policy: The Case of Italian Public Debt

Using the simple arithmetic of government budget constraint, we perform an illustrative analysis on the Italian case, investigating the consequences on the main public finance aggregates of the adoption of a fiscal policy rule responding to past real debt/GDP ratio. Such a rule, firmly grounded in the economic analysis, would allow the reduction of Italy's outstanding stock of debt without requiring the strict adherence to the 3 per cent criterion for deficit/GDP ratio, as prescribed by SGP (Stability and Growth Pact). We perform a forecasting exercise under five alternative scenarios and analyse the details of a structural debt reduction strategy with alternative yearly step.     

The macroeconomic effects of tax changes: Evidence using real-time data for the European Union

This paper examines the macroeconomic effects of tax changes in the European Union between 2000 and 2016. The novelty of our approach hinges on the use of real-time estimates of discretionary fiscal adjustments. In particular, exploiting a unique database covering anticipated and unanticipated tax changes, we provide the first narrative panel estimates of output and employment multipliers for tax changes. Our results suggest that medium-term revenue-based output multipliers are in the range of −1.1 to −1.9 for unanticipated tax changes. Preannounced changes, on the other hand, temporarily impact economic activity inversely upon announcement, resulting in a less than one-to-one change in ex post tax receipts, but portray up to one percentage point larger employment responses. Finally, we find evidence of asymmetry between the effects of revenue increasing and decreasing measures in the European Union.     

Independent fiscal councils: Recent trends and performance

Countries increasingly rely on independent fiscal councils to constrain policymakers’ discretion and curb the bias towards excessive deficits and pro-cyclical policies. Since fiscal councils are often recent and heterogeneous across countries, assessing their impact is challenging. Using the latest (2016) vintage of the IMF Fiscal Council Dataset, we focus on two tasks expected to strengthen fiscal performance: the preparation or assessment of forecasts, and the monitoring of compliance with fiscal rules. Tentative econometric evidence suggests that the presence of a fiscal council is associated with more accurate and possibly less optimistic fiscal forecasts, as well as greater compliance with fiscal rules.     

Fiscal transparency, political parties, and debt in OECD countries

Many believe and argue that fiscal, or budgetary, transparency has large, positive effects on fiscal performance. However, the evidence linking transparency and fiscal policy outcomes is less compelling. To analyze the effects of fiscal transparency on public debt accumulation, we present a career-concerns model with political parties. This allows us to integrate as implications of a single model three hitherto-separate results in the literature on deficit and debt accumulation: that transparency decreases debt accumulation (at least by reducing an electoral cycle in deficits), that right-wing governments (at least for strategic reasons) tend to have higher deficits than left-wing governments, and that increasing political polarization increases debt accumulation. To test the predictions of the model, we construct a replicable index of fiscal transparency on 19-country OECD data. Simultaneous estimates of debt and transparency strongly confirm that a higher degree of fiscal transparency is associated with lower public debt and deficits, independent of controls for explanatory variables from other approaches.     

Government solvency and financial markets: Dynamic panel estimates for the European Monetary Union

We assess government solvency in the European Monetary Union (EMU), controlling for the interaction of fiscal policy with financial markets. We find a positive interaction, reflecting market-based pressures for fiscal improvement, and significant debt stabilization efforts, weakened in the post-EMU era.     

Fiscal institutions and public spending volatility in Europe

This work provides empirical evidence for a sizeable, statistically significant negative impact of the quality of fiscal institutions on public spending volatility for a panel of 23 EU countries over the 1980–2007 period. The dependent variable is the volatility of discretionary fiscal policy, which does not represent reactions to changes in economic conditions. Our baseline results thus give support to the strengthening of institutions to deal with excessive levels of discretion volatility, as more checks and balances make it harder for governments to change fiscal policy for reasons unrelated to the current state of the economy. Our results also show that bigger countries and bigger governments have less public spending volatility. In contrast to previous studies, the political factors do not seem to play a role, with the exception of the Herfindahl index, which suggests that a high concentration of parliamentary seats in a few parties would increase public spending volatility.     

Boosting confidence: Is there a role for fiscal policy?

This paper investigates the widely held view that expansionary fiscal policy can boost consumer and business confidence, which will stimulate private spending and sustain economic activity. We find evidence in favor of this conjecture, i.e., cuts in direct taxes generate a positive effect on consumer and business confidence, while the same applies in cases of higher non-wage government consumption. However, higher government wage bills and government investment reduce confidence, with the effect being more pronounced when the Debt to GDP ratio is high, possibly because they entail a permanent increase in the size of the public sector, which would have to be financed by higher future taxes.     

Fiscal sustainability,volatility and oil wealth

Whether fiscal policy is sustainable depends on a government’s future revenue and expenditure streams, both of which are highly uncertain. In commodity‐rich countries, this problem is intensified by unpredictable and volatile commodity prices. We show how spending rules for oil income and non‐oil primary deficits interact and influence the stochastic distribution of future debt stocks and demonstrate the variance reducing impact of feedback rules for primary deficits in a case study of oil‐and‐gas exporter Azerbaijan.     

Do fiscal rules cause better fiscal balances? A new instrumental variable strategy

This paper estimates the causal effect of fiscal rules on fiscal balances in a panel of 142 countries over the period 1985–2015. Our instrumental variable strategy exploits the geographical diffusion of fiscal rules across countries. The intuition is that reforms in neighboring countries may affect the adoption of domestic reforms through peer pressure and imitational effects. We find that the mere existence of fiscal rules correlates with lower deficits, but the positive link disappears when endogeneity is correctly addressed. However, when considering the strength of rules through a continuous index of fiscal rules’ design, we show that well-designed rules have a statistically significant impact on fiscal balances. We conduct several robustness tests and show that our results are generally robust and not affected by weak instrument problems.     

Non-linear budgetary policies: Evidence from 150 years of Italian public finance

We investigate the sustainability of Italy’s public finances from 1862 to 2012 adopting a non-linear perspective. Specifically, we employ the smooth transition regression approach to explore the scope for non-linear fiscal adjustments of primary surpluses in response to the accumulation of debt. The empirical results show the occurrence of a significantly positive reaction of primary surpluses to debt when the debt–GDP ratio exceeded the trigger value of 110 percent. The after-threshold positive response implies that the path of Italy’s fiscal policy is sufficiently consistent with the intertemporal budget constraint.     

How Does Fiscal Consolidation Impact on Income Inequality?

In this paper, we assess the impact of fiscal consolidation on income inequality. Using a panel of 18 industrialized countries from 1978 to 2009, we find that income inequality significantly rises during periods of fiscal consolidation. In addition, while fiscal policy that is driven by spending cuts seems to be detrimental for income distribution, tax hikes seem to have an equalizing effect. We also show that the size of the fiscal consolidation program (in percentage of GDP) has an impact on income inequality. In particular, when consolidation plans represent a small share of GDP, the income gap widens, suggesting that the burden associated with the effort affects disproportionately households at the bottom of the income distribution. Considering the linkages between banking crises and fiscal consolidation, we find that the effect on the income gap is amplified when fiscal adjustments take place after the resolution of such financial turmoil. Similarly, fiscal consolidation programs combined with inflation are likely to increase inequality and the effects of fiscal adjustments on inequality are amplified during periods of relatively low growth. Our results also provide support for a non‐linear relationship between inequality and income and corroborate the idea that trade can promote a more equal distribution of income.