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This paper was written while the author was in the Western Division of the European I Department. The author is grateful to Enrica Detragiache, Luc Everaert, Marcello Estevão, Robert Ford, Francisco Nadal-De Simone, and Kenneth West for useful comments and corrections. The usual comment about remaining error applies.
The Ricardian equivalence proposition states that “…budget deficits or social security would not matter for key macroeconomic variables, such as the real interest rate and the quantity of investment,” since the debt needed to finance those disequilibria will be paid by raising taxes in the future (Barro, 1996); therefore, the proposition implies that optimal private consumption paths will not be affected by temporary changes in taxes and transfers, since agents will predict a reversal of those changes consistent with an intertemporal balanced position of the public accounts.
However, saving behavior can be destabilizing in some cases, for example, when a slowing economy leads to an increase in precautionary savings due to higher job insecurity and lower earnings prospects. Additionally, there could be a role for fiscal stabilization even in a world where the Ricardian proposition holds perfectly, as shown in Christiano (1984).
De Long (1996) explores how these Keynesian ideas influenced U.S. public budget legislation after the Second World War.
Note, however, that fiscal feedback rules and automatic built-in stabilizers are not the same. Fiscal feedback rules are policy actions based on present and past information shared by both the government and private agents; built-in stabilizers respond automatically to current economic conditions. McCallum and Whitaker (1979), using a rational expectations macroeconomic model that includes a supply curve of the “natural type” conclude that fiscal feedback rules are ineffective while built-in automatic stabilizers may influence the variability of output around potential levels. However, Beare (1986), using a similar model finds that fiscal stabilizers may increase output volatility provided they affect the elasticity of aggregate supply.
These papers intended to assess the quantitative impact of fiscal stabilizers for the United States.
These two authors use the Blanchard-Quah procedure to identify their model. The main aim of their paper is to estimate prudent budgetary margins to avoid breaching the Maastricht Treaty’s 3 percent deficit ceiling.
Using the Federal Reserve Board (FRB)/U.S. macro econometric model, Cohen and Follete find that automatic stabilizers reduce the Keynesian multiplier by approximately 10 percent, although they have a larger impact on personal consumption. This result is similar to the one obtained by Auerbach and Feenberg, who report that federal taxes offset approximately 8 percent of initial shocks to GDP.
All previous period variables are denoted with a -1 subscript.
Transitory components of private consumption and investment are expected to be positively correlated with the transitory components of households’ disposable income and net earnings of entrepreneurs, respectively. If this the case, larger fluctuations in disposable income will generate larger fluctuations in both private consumption and investment, and therefore, in output. In addition, since the transitory component of consumption is assumed to be affected by the contemporaneous transitory component of households’ disposable income and its first lag, both the static and dynamic effectiveness of fiscal stabilizers can be analyzed.
The more open an economy is, the smaller the effect of fiscal stabilizers should be. The model presented here captures the effect on the trade balance of the elimination of automatic stabilizers by focusing the analysis on imports of goods and services. Exports are assumed to be unaffected by fluctuations in domestic demand, which will be reflected only in the behavior of imports. Then, if private consumption and investment are more variable due to the absence of automatic stabilizers, the temporary component of imports will be more volatile too. The validity of this assumption will be tested for the case of France.
Henceforth in the paper, we will refer
For simplicity, when defining households’ disposable income and net income of entrepreneurs, only a generic tax was included; however, this generic tax should be interpreted as a weighted average of taxes and transfers, each one with its own elasticity with respect to changes in income.
In the absence of perverse effects, the transitory component of government revenues should move in the same direction as the transitory component of output, and some government expenditures, specifically transfers, in the opposite direction.
In (13), the condition |z1| < 1 must hold in order for the difference equation to converge. This must be the case, since otherwise the expression would not be a difference equation in temporary percentage changes of output. The numerator of the coefficient will be positive provided that
A good reference on decompositions of series between permanent and temporary components and the problems associated with them is De Masi (1997).
The stationarity of all series was tested using augmented Dickey-Fuller tests, which are available on request.
During 1975-99, zl was on average 0.45 with stabilizers while it was 0.47 without them, whereas in the case of z2 the figure with stabilizers was 1.01 and 1.03 without stabilizers.
The source of all data series is the IMF’s World Economic Outlook database.
During the period 1997-2000, imports of goods and services increased to an average higher than 24 percent of GDP.
Government expenditures referred to in this paragraph are measured according to national accounts definitions, i.e., they do not include transfers. General government expenditures as measured in the fiscal accounts—which do include transfers—show the same correlation signs when split in their components, i.e., the temporary component of general government consumption expenditure is negatively correlated with the cycle as well as employee compensation—one of its component parts—while capital expenditure is procyclical.
Regression coefficients of temporary private consumption against contemporaneous temporary HHDY and its first lag are economically and statistically significant which supports our formulation of temporary consumption.
Figures of the levels of these macroeconomic variables as well as of taxes and transfers, their fitted long-term values, and the series without the effect of automatic stabilizers are included in Appendix II.
The root mean square error is defined as
and j is the number of years for which the root mean square error is calculated; x denotes the original series while x* denotes the potential series. Potential series were constructed using the ARIMA processes reported in Appendix II, Tables A1-A3. In the case of output we used two measures of potential output, one constructed by means of the ARIMA process reported in Table A1 and the one obtained in IMF (2000) by means of a state space model that simultaneously estimates the natural rate of unemployment.
This way of measuring the effectiveness of fiscal stabilizers is also used by van den Noord (2000).
The Spanish Parliament has recently adopted a balanced budget rule.
There are several issues related to the counter factual estimation of the effects of such a rule. First, a new series for government interest payments should be calculated beginning in the year after the “implementation” of the rule. The new series should reflect the fact that public debt would not change and thus annual changes in interest payments would be caused only by changes in interest rates. Second, new series of taxes should be calculated in order for the fiscal accounts to be balanced. The method used here was to maintain unaltered the proportions of each component of revenues in total revenues while changing total revenues to make them equal to the new series of general government expenditures. This procedure has some drawbacks. First, output fluctuations will be different, depending on the year chosen as the initial period of implementation of the rule. Second, potential output will be different than the original series and therefore comparisons of relative fluctuations using the RMS of gaps will be unavailable.