Fiscal Policy in New EU Member States: Go East,Prudent Man!

The European Union accepted 10 new member states (NMS) in 2004, eight of which were former socialist countries. New members have had to adjust their economic policies to EU standards. Perhaps most difficult has been fiscal policy, where NMS must comply with the Stability and Growth Pact rules. Indeed, four of the eight post-communist NMS breached the SGP limits and were put in the Excessive Deficit Procedure. While the SGP is being modified, fiscal policy is set to remain on the agenda for all NMS.

This article analyses fiscal policy in the eight NMS, focusing primarily on the period immediately preceding their EU accession. The structure and scale of these countries' fiscal policy are analysed and the main trends in the revenue and expenditure of their public budgets identified. Then the dynamics of fiscal policies in the NMS are explored and the main factors in them isolated. The authors show how much of the consolidation was due to the fiscal authorities' effort and how much was caused by external factors. They also show that most NMS governments have run rather inconsistent fiscal policies and have not consolidated their budgets appropriately, postponing politically difficult consolidation measures. However, they also identify a group of countries characterised by strong reform efforts and responsible fiscal policy making, supported usually by strong economic growth. In this context, room is given to economic as well as political economy factors.     

ACCRUAL BUDGETING AND FISCAL CONSOLIDATION IN THE EMU

Drawing on modern macroeconomic literature focusing on the study of politico-institutional determinants of public policies, this article analyzes the institutional design of the European fiscal policy laid down by the Treaty of Amsterdam and the Stability and Growth Pact. Both documents provide countries in the EU, and in particular those that have adopted the euro, with a common code of fiscal conduct that is expected to uphold discipline in the management of government finances. Nevertheless, a simple review of this code of conduct shows the existence of serious drawbacks mainly derived from the asymmetry between the treatment given to outcomes of fiscal policy in comparison with that given to the procedures followed in generating them. It seems that the current design of the European fiscal coordination system does not really take into account the findings of modern macroeconomics and does not pay due attention to the relation between budgetary processes/institutions and outcomes in fiscal policy. Moreover, this article argues that in the implementation of the broad reforms needed to achieve a sustainable fiscal consolidation, there are political complementarities (in the sense that the ability to gain political consent for one reform depends on the acceptance of other reforms) between the setting up of new fiscal policies of expenditure containment and new fiscal procedures.
All in all, this analysis points to a sorely needed procedural reform in public sector budgeting as the best contribution to pursuing the stabilization of European public finances: the fuller use of accrual concepts in budget reporting. Much more than an isolated technical exercise, the shift to accrual budgeting could be quite a useful tool to facilitate wider reforms aimed at improving public sector financial management and performance while enhancing transparency and accountability.     

Political and Fiscal Risk Determinants of Sovereign Spreads in Emerging Markets

Using a panel of 46 emerging market economies from 1997 to 2008, this paper investigates the key determinants of country risk premiums as measured by sovereign bond spreads. Unlike previous studies, the results indicate that both political and fiscal factors matter for credit risk in emerging markets. Lower levels of political risk are associated with tighter spreads, particularly during financial turmoil. Efforts at fiscal consolidation narrow credit spreads, especially in countries with high initial public debt levels. The composition of fiscal policy also matters as higher public investment lowers spreads as long as the fiscal position remains sustainable and the fiscal deficit does not worsen.     

Social polarization, fiscal instability and growth

We present a dynamic model of fiscal policy in a simple growth framework where social polarization (of preferences) plays a central role in the evolution of fiscal instability and growth collapse. In a highly polarized society, a deficit occurs endogenously, fiscal spending path becomes more volatile, output collapses, and economic growth rate is reduced along the transition path to a new lower level of output. One novel feature is that the size of fiscal deficit, the magnitude of fiscal volatility, and the size of reduction in output and growth rate are explicitly shown to be increasing functions of the degree of social polarization. This is because of the positive relationship between the polarization of preferences and the incentive for policymakers (or socio-economic groups) to overexploit the government resources in a common pool setting (polarization effect). Thereby, we offer a fiscal instability channel that negatively links social polarization and growth, which is an alternative yet distinct explanation for the empirical finding that social polarization is harmful to growth. Moreover, we fully distinguish the incentive to engage in such short-term policies under political uncertainty from that under polarization. Polarization and political uncertainty are shown to be distinct yet critical to the dynamic coordination failure in the common pool setting.     

Policy mix and debt sustainability: evidence from fiscal policy rules

This paper characterizes rules-based fiscal policy setting for G-3 and large EMS countries. We set up a simple fiscal policy rule and then infer on the policymakers’ reaction coefficients by testing with GMM. Our results qualify existing evidence on systematic fiscal policy in two respects. First, fiscal policy usually stabilizes public debt; and there is indeed substantial interaction between fiscal and monetary policies via the policy mix or the debt channel. Second, sustainability is achieved with a “stop–go” cycle of consolidation. Unless debt ratios are high, consolidation does not come at the cost of less cyclical stabilization.     

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.     

Big Brother is also being watched: Measuring fiscal credibility

Fiscal policy is less credible than monetary policy, due to political economy issues. This paper provides an explicit measure of fiscal credibility, based on the anchoring of private expectations onto official targets. It documents how credibility varied among a sample of 27 European countries over 1995–2019. Credibility behaves like a stock of trust that is affected by fiscal policy, past performance, and institutions (fiscal rules and councils). This paper highlights how regular government communication – budgets and fiscal plans – is crucial to anchor expectations and buttress credibility. Last, it shows that credibility is associated with better sovereign financing conditions. Governments should thus strive to maintain their credibility.     

Are the effects of fiscal policy really nonlinear? A note

Based on a panel data model, Giavazzi, Jappelli and Pagano (2000, European Economic Review 44, 1259–1289) recently found evidence that national saving in OECD countries responds nonlinearly to fiscal policy, the nonlinearity being associated with the size and persistence of the fiscal impulse. The existence of this nonlinearity would have important policy implications because it implies that the short-run costs of a fiscal consolidation program are lower the larger and more persistent it is. However, this paper shows that their finding is not robust, one reason being the inadequacy of the slope homogeneity assumption implicit in their panel model and another reason being their reliance on an implausibly large number of episodes of large and persistent fiscal impulses.     

The Effects of Fiscal Consolidation and Welfare Composition of Spending on Electoral Outcomes: Evidence from US Gubernatorial Elections between 1978 and 2006

This study attempts to make a contribution to the field of spending aspects of fiscal policy and their impacts on electoral outcome. Due to varying degrees of financial responsibilities and commitments to provide public goods and services, US state governments serve as a perfectly natural laboratory to test the electoral significance of fiscal policies. We adopt a probit model, with several specifications, to determine significant impacts of fiscal consolidation and increases in welfare spending on US gubernatorial elections from 1978 to 2006. The analyses show that voters are more concerned about the increase in debt than current budget deficits. An increase in welfare spending is negatively associated with reelection. Moreover, the impact of taxation on gubernatorial elections turns out to be insignificant. In particular, findings suggest that the political business cycle model does not hold true in US gubernatorial elections. Expansionary fiscal policy right before the election may not have crucial impacts on the chances of an incumbent winning the election.     

FiMod — A DSGE model for fiscal policy simulations

This paper develops a medium-scale dynamic, stochastic, general equilibrium (DSGE) model for fiscal policy simulations. Relative to existing models of this type, our model incorporates two important features. First, we consider a two-country monetary union structure, which makes it well suited to simulate fiscal measures by relatively large countries in a currency area. Second, we provide a notable degree of disaggregation on the government expenditures side, by explicitly distinguishing between (productivity-enhancing) public investment, public purchases and the public sector wage bill. In addition, we consider a labor market characterized by search and matching frictions, which allows to analyze the response of equilibrium unemployment to fiscal measures. In order to illustrate some of its applications, and motivated by recent policy debate in the Euro Area, we calibrate the model to Spain and the rest of the area and simulate a number of fiscal consolidation scenarios. We find that, in terms of output and employment losses, fiscal consolidation is the least damaging when achieved by reducing the public sector wage bill, whereas it is most damaging when carried out by cutting public investment.     

Fiscal Consolidations: A Theoretical Essay with a Heterogeneous-Agent Model

Since the emergence of the financial crisis, most of the EU countries have promoted impressive public interventions to support financial institutions, contributing to a significant rise in general government gross debt-to-GDP ratios. As such, the issue of how to best pursue a fiscal consolidation will become crucial regarding the fiscal policy stance. This paper aims at characterizing four different stylized debt consolidation strategies extensively identified in the literature (one pure revenue-based and three expenditure-based) in order to assess welfare affects and, in particular, the inequality effects involved. For this purpose, we built a general equilibrium heterogeneous-agent model capable of exploring the relationship between fiscal policy and the endogenous cross-section distribution of income and wealth. Moreover, we decompose the impacts on welfare criteria in order to distinguish pure efficiency effects from insurance and inequality effects. According to our simulations, the adjustment based on the reduction of unproductive expenditures came out to be the most welfare-enhancing compared to those based on tax increases or on social transfer reductions.     

Fiscal consolidation with high growth: A policy simulation model for India

In this paper a fiscal consolidation program for India has been presented based on a policy simulation model that enables us to examine the macroeconomic implications of alternative fiscal strategies, given certain assumptions about other macro policy choices and relevant exogenous factors. The model is then used to estimate the outcomes resulting from a possible strategy of fiscal consolidation in the base case. The exercise shows that it is possible to have fiscal consolidation while at the same time maintaining high GDP growth of around 8% or so. The strategy is to gradually bring down the revenue deficit to zero by 2014–15, while allowing a combined fiscal deficit for centre plus states of about 6% of GDP. This provides the space for substantial government capital expenditure, which translates to a significant public investment program. This in turn leads to high overall investment directly and indirectly, via the crowding in effect on private investment, which drives the high GDP growth. The exercise has also tested the robustness of this strategy under two alternative scenarios of higher and lower advanced country growth compared to the base case.     

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.     

The dynamics of Greek public debt – evidence from simultaneous and structural VAR models

The goal of the present article was to investigate not only the dynamics of the Greek public debt, but also the appropriate measures required for achieving fiscal consolidation. The empirical estimation is carried out using a macroeconomic data set spanning the period 1980–2008 and both the three-stage least squares (3SLS) methodological approach on a theoretical model and the structural VAR methodology to perform forecast tests and to calibrate the future paths of the public debt variable up to 2020. The results suggest that only a restrictive fiscal policy that simultaneously increases government revenues and reduces government expenditure could permit the country to achieve debt sustainability. The results also suggest that debt sustainability can be achieved faster when tax revenue policies are intensified. The results are expected to have important implications to policymakers for designing effective macroeconomic policy in terms of achieving sustainable levels of public debt.     

The employment effect of changes in the composition of fiscal consolidations

This paper assesses the magnitude and nature of fiscal consolidation policies and their impact on employment. In particular, in an attempt to address fiscal imbalances in the near term, countries have been faced with the delicate challenge of doing so without damaging recovery prospects and thus, counter to their original aim, worsening further public finances. In this regard, the paper reviews recent austerity measures adopted by governments and discusses how prolonging fiscal consolidation measures in their current form could be counterproductive for guaranteeing debt sustainability. Moreover, the article shows how poorly designed fiscal cuts – directly or indirectly affecting labour – seem to have been dampening job prospects. The paper sheds light on how fiscal and employment goals can be achieved together. More specifically, it finds that a fiscally-neutral change in the expenditure and revenue composition of fiscal consolidation can boost job creation. In this sense, the paper shows that it is imperative to find the right policy mix and recommends countries to be mindful of the nature and pace of consolidation.     

The Salient Issue of Issue Salience

This paper proposes a model where the set of issues that are decisive in an election (i.e., the set of salient issues) is endogenous. The model takes into account a key feature of the policy-making process, namely, that the decision-maker faces time and budget constraints that prevent him from addressing all of the issues that are on the agenda. We show that this feature creates a rationale for a policy-motivated decision-maker to manipulate his policy choice in order to influence which issues will be salient in the next election. We identify three motivations for the decision-maker to manipulate his policy choice for salience purposes. One is to make salient an issue on which he has an electoral advantage. A second motivation is to defuse the salience of an issue on which he is electorally weak, which is accomplished by either implicitly committing to a policy outcome or triggering a change of salient issue for the challenger. A third motivation is to induce the opposition party to nominate a candidate who, if elected, will implement a policy that the incumbent decision maker finds more palatable.     

Fiscal Policy to Stabilise the Domestic Economy in the EMU: What Can We Learn from Monetary Policy?

An important issue for the EMU countries is to what extent fiscalpolicy can be used to stabilise the domestic economy in thecase of asymmetric macroeconomic shocks. The paper reviews possiblereforms of national fiscal policy institutions in order to promoteefficient fiscal stabilisation policy: (i) the introductionof a more transparent legal framework for the government's stabilisationdecisions; (ii) the establishment of an independent advisoryFiscal Policy Council; and (iii) the delegation of actual stabilisationdecisions to an independent Fiscal Policy Committee. The conclusionis that the Fiscal Policy Committee solution has much to speakfor itself. It seems possible to delegate fiscal stabilisationpolicy decisions, in much the same way as monetary policy hasbeen delegated to central banks, at the same time as fiscalpolicy decisions focusing on income distribution and socialefficiency are kept in the political sphere. Such delegationcan be made compatible with democratic accountability. (JELE61, E63, P16)     

MACROECONOMIC POLICY AND ELECTIONS IN OECD DEMOCRACIES*

The purpose of this paper is to test for evidence of opportunistic “political business cycles” in a large sample of 18 OECD economies. Our results can be summarized as follows: 1) We find very little evidence of pre-electoral effects on economic outcomes, in particular, on GDP growth and unemployment; 2) We see some evidence of “political monetary cycles,” that is, expansionary monetary policy in election years; 3) We also observe indications of “political budget cycles,” or “loose” fiscal policy prior to elections; 4) Inflation exhibits a post-electoral jump, which could be explained by either the pre-electoral “loose” monetary and fiscal policies and/or by an opportunistic timing of increases in publicly controlled prices, or indirect taxes.     

The Dutch experience: Assessing the welfare impacts of two consolidation strategies using a heterogeneous-agent framework

Between 1990 and 2010, the Dutch government pursued two successful fiscal adjustments: first, in 1995–2002, through a pure expenditure-based strategy and second, in 2004–2007, through a mixed strategy based on social transfer cuts and tax increases. In order to assess welfare and, in particular, inequality effects involved in each episode, we built a general equilibrium model with heterogeneous-agent capable of exploring the relationship between fiscal policy variables and the endogenous cross-section distribution of income, wealth and welfare.The results confirm that, for the Netherlands, a pure expenditure-based strategy is slightly superior relative a (partial) revenue-based one. In spite of positive welfare gains, the model predicts significant transition costs in both episodes due to depletion of insurance capacity, higher inequality and output losses. Moreover, as supported by the data, the model simulations show an improvement of the net foreign asset position in the sequence of the debt-consolidation processes. Finally, the two consolidation episodes, described throughout the paper strengthen the relevance of political institutions as important successful factors.     

What is the right balance between US monetary and fiscal policy? Explorations using simulated wavelet-based optimal tracking control

This paper uses wavelet-based optimal control to simulate fiscal and monetary strategies under different levels of policy restrictions. The model applies the maximal overlap discrete wavelet transform to US quarterly GDP data and then uses the decomposed variables to build a large 80-dimensional state-space linear-quadratic tracking model. Using a political targeting design for the frequency range weights, we simulate jointly optimal fiscal and monetary policy where: (1) both fiscal and monetary policy are dually emphasized, (2) fiscal policy is unrestricted while monetary policy is restricted to achieving a steady increase in the market interest rate, (3) only monetary policy is relatively active, while fiscal spending is restricted to achieving a target growth rate, and (4) monetary policy emphasizes short-run stabilization, while fiscal policy utilizes political cycle targeting. The results show that fiscal policy must be more aggressive when the monetary authorities are not accommodating the fiscal expansion and that the dual-emphasis policy leads to a series of interest rate increases that are balanced between a steadily increasing target and a low, fixed rate. This research is the first to construct integrated fiscal and monetary policies in an applied wavelet-based optimal control setting using US data.