Monetary and Exchange Rate Policies of the Euro Area: Selected Issues
Author: International Monetary Fund
Publication Date:
06 Nov 2001
eISBN:
9781451812992
Language:
English
Keywords:
ISCR; CR; price; fiscal policy response; growth fluctuation; anticyclical fiscal policy action; SGP state; growth surprise; Tax allowances; Procyclical fiscal policy; Fiscal stance
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This Selected Issues paper estimates the potential output and the associated nonaccelerating inflation rate of unemployment in the euro area. The study presents a conceptual framework for analyzing currency movements, and highlights the transmission of import price shocks on consumer prices. The paper compares different measures of trend money growth, and analyzes the monetary conditions. The study describes the stability and growth pact, outlines a simple framework for studying fiscal policy behavior, and estimates European Union countries' past cyclical fiscal policy responses to output growth fluctuations.

Abstract

This Selected Issues paper estimates the potential output and the associated nonaccelerating inflation rate of unemployment in the euro area. The study presents a conceptual framework for analyzing currency movements, and highlights the transmission of import price shocks on consumer prices. The paper compares different measures of trend money growth, and analyzes the monetary conditions. The study describes the stability and growth pact, outlines a simple framework for studying fiscal policy behavior, and estimates European Union countries' past cyclical fiscal policy responses to output growth fluctuations.

V. Cyclical Fiscal Policy Behavior in EU Countries1

A. Introduction and Summary

1. This chapter provides further background to the discussion of the Stability and Growth Pact (SGP) in the euro area report.2 The chapter proceeds in four steps. First, it outlines a simple framework for studying fiscal policy behavior in response to output growth fluctuations. Second, it uses this framework to estimate EU countries’ past cyclical fiscal policy responses to output growth fluctuations. Third, it presents evidence on features of EU countries’ fiscal institutions that may help account for past cross-country differences in cyclical fiscal policy behavior. And fourth, the chapter briefly assesses the SGP’s potential to rectify past flaws in fiscal policy behavior.

2. The chapter’s main conclusions can be summarized in five bullet points:

  • In most EU countries, past fiscal policy behavior delivered neither sustained fiscal discipline nor helped much in stabilizing the macroeconomy. In particular, discretionary fiscal policy responses in many countries were procyclical, muffling in part or fully the operation of automatic fiscal stabilizers.

  • Fiscal policy behavior in most EU countries was not symmetric over the business cycle—procyclicality was more pronounced during “good economic times” (defined as periods of above-average GDP growth). This asymmetry bias implies an upward ratcheting of underlying fiscal deficits in good times, suggesting that procyclical policy behavior and lack of sustained fiscal discipline could represent two sides of the same coin.

  • Procyclical fiscal policy behavior in many EU countries appears to be hardwired into present institutional arrangements. This is suggested by time series evidence based on (OECD) forecast errors for fiscal balances and real GDP growth. Forecast errors for fiscal balances in these countries respond only weakly to forecast errors for real GDP growth, consistent with the view that offsets to automatic fiscal stabilizers occurred in a quasi-automatic fashion rather than through fiscal actions based on a deliberate policy process.

  • From a cross-country perspective, procyclical fiscal policy behavior in EU countries was associated with lax fiscal constraints on deficits and debt (proxied by accumulated public debt levels), the size of pay-as-you-go (PAYG) social insurance systems, and, to a lesser extent, the size of countries’ lower government sectors.

  • For many EU countries, the new “rules of the game” enshrined in the SGP hold the promise of a regime break with past patterns of fiscal laxity as well as procyclical fiscal policy behavior. However, some of the evidence presented in this chapter also suggests that locking in such a regime change may require an adaptation of longstanding institutional arrangements.

B. An Analytical Framework

3. The change in the actual fiscal balance as a percent of GDP (Δbt) can be written as the sum of the change in the fiscal balance due to the operation of automatic fiscal stabilizers (Δbat) in response to output growth fluctuations and the change in the fiscal balance due to other factors (Δbst):

(1) Δbt = Δbat + Δbst,

(2) Δbt = α(Δyt - μ)

where (Δyt − μ) is the deviation of real GDP growth from average growth or drift (μ), and the automatic fiscal response parameters α measures the automatic responses of the actual balance-GDP ratio to a 1 percentage point increase in real output growth (relative to drift).3 In equation (1), the change in the structural balance (Δbst) is a catch-all term for the many other factors driving fiscal positions. The change in the structural balance can be decomposed into a component that picks up any discretionary responses to real GDP growth fluctuations and the remaining change in the structural component that is uncorrelated with real GDP growth fluctuations (Δbut):

(3) Δbt = β(Δyt − μ) + Δbμt,

where the parameter β measures the “discretionary” response of the structural balance to real output growth fluctuations. The sign of the discretionary response parameter β can be used to classify changes in the structural balance as countercyclical (β positive) or procyclical (β negative).4 Combining equations (l)‒(3) yields:

(4) Δbt = (α + β)(Δyt − μ) + Δbut.

4. In the empirical portion of the paper, it will be assumed that the automatic response parameter (α) is constant and known. Time series data on the fiscal balance and output growth fluctuations are used to infer information about the parameter β and the time series behavior of the autonomous (with respect to output growth) changes in the budget balance (Δbut). As regards the latter term, all regressions below assume that this term is white noise.5

5. The framework outlined in this section can also be used to shed light on two additional issues: First, is fiscal policy behavior symmetric with respect to fast and slow output growth? And second, to what extent is procyclical fiscal policy behavior ingrained in a country’s fiscal institutions in the sense that discretionary policy responses are quasi-automatic rather than the result of deliberate policy making?

6. To test for possible asymmetries in the discretionary response of fiscal policy to output growth fluctuations, equation (4) can be augmented to allow for different response parameters depending on whether output growth relative to drift (Δyt − μ) takes positive or negative values:

(5)Δbt=(α+β+)(Δyt−μ)(It+)+(α+β−)(Δyt−μ)(It−)+Δbut

where It is an indicator function, defined as:

It+=1if(Δyt−μ)≥0andIt+=0if(Δyt−μ)<0(6)It−=1if(Δyt−μ)<0andIt−=1if(Δyt−μ)≥0.

7. A test of how ingrained procyclical fiscal policy responses are in fiscal institutions can be based on readily available one-year-ahead forecast errors for the change in the fiscal balance (Δbt − fΔbt) and for real GDP growth (Δyt − fΔyt). Using equation (3), these forecast errors are related as:

(7) (Δbt − fΔbt) = (α + β)(Δyt − fΔyt) + (Δbut − fΔbut).

8. Since the fiscal policy surprise (Δbut − fΔbut) is uncorrelated with the forecast error for output growth, a regression based on (7) can be used to estimate (α+β). The estimated parameter combines the (current) automatic fiscal stabilizer response and the (current) intra-year fiscal policy response to the GDP growth surprise. Assuming the (current) automatic fiscal stabilizer response is known, an estimate of β can be recovered and used as a proxy for the intra-year fiscal policy response to a real GDP growth surprise. If the estimate of β offsets the automatic stabilizer response, this can be interpreted as evidence that the intra-year fiscal policy response is procyclical and likely to reflect fiscal institutions bent on meeting nominal balance targets.

9. Two features of the framework laid out in this section—the use of first differences of fiscal variables; and the absence of cyclical output gaps—warrant brief comment:

  • The framework’s use of first differences (instead of levels) of fiscal variables allows to apply standard variance-covariance analysis tools. In most industrial countries, fiscal variables appear to be nonstationary in levels during the last few decades, rendering the application of standard statistical tools doubtful.

  • The framework uses GDP growth rates instead of output gaps as indicators of output fluctuations. This follows a suggestion by Blanchard (1990, p. 6) who argued that adopting a “marginal approach” to analyzing automatic fiscal stabilizers based on GDP growth rates allows to avoid controversial measurement issues regarding the output gap.

C. Past Cyclical Fiscal Policy Behavior: Time Series Evidence

10. The time series analysis uses data for general government balances (as a percent of nominal GDP)6 and real GDP growth covering 1978-2000. Two reasons account for not using available time series before 1978. First, fiscal policy behavior in several industrial countries underwent a regime break during the 1970s.7 And second, discarding observations before 1978 also appears appropriate in view of the analysis’ assumption of a constant parameter value for the automatic fiscal stabilizer coefficient α. The size of automatic stabilizers depends sensitively on the size of the revenue-GDP ratios, which rose sharply in many industrial countries during the 1970s.

11. The constant numerical values for the automatic fiscal stabilizer coefficient α (including current and lagged effects) are shown in Table 1. These constant values are based on staff estimates of automatic stabilizer responses used in the context of estimating structural balance positions.8 A breakdown of the automatic balance response into contributions of revenue and expenditure (first decomposition shown in Table 1.), suggests that revenue account for most of the automatic response to output fluctuations. In particular, for the euro area as a whole, about 85 percent of the automatic balance response is due to revenues while the remainder reflects the automatic response of unemployment benefits to the cycle, which, however, occurs partly with a lag. The breakdown of the automatic balance response into contributions of current and lagged responses (second decomposition shown in Table 1) indicates that lagged responses account for a small portion (7 percent) of the overall automatic stabilizer response.

Table 1.

EU Countries: Estimates of Automatic Responses of General Government Balance-GDP Ratio to Real GDP Growth Fluctuations

article image
Source: Staff estimates.

Staff estimates of automatic or built-in percentage point change in the ratio of general government balance to GDP in response to a 1 percentage point increase in real GDP. The calculation of these parameter estimates is described in IMF (1998b).

Weighted averages.

12. The drift term (μ) of GDP growth was assumed to be constant for all countries during 1978-2000 except for Ireland, Luxembourg, and Japan. In the case of the latter countries, the drift term was approximated by Hodrick-Prescott (HP) filter estimates.9

13. The regression evidence clearly confirms the—by now conventional—view that fiscal policy behavior in most EU countries during the last two decades had a strong procyclical bent (Table 2).10 The estimated discretionary fiscal response coefficient (including current and lagged responses) to output growth is negative for all EU countries except Denmark, Finland, and Sweden. Thus, in all EU countries apart from the three Scandinavian countries, the operation of automatic fiscal stabilizers was at least in part offset by discretionary actions. In the case of four EU countries (Belgium, Germany, Ireland, Italy), the overall net fiscal response (defined as the sum of the total automatic fiscal stabilizer and discretionary response coefficients) to real output growth fluctuations was negative (Figure 1).

Table 2.

EU Countries: Estimates of Discretionary Responses of General Government Balance-GDP Ratio to Real GDP Growth Fluctuations, 1978-2000

article image
Source: Staff estimates.

Estimates of discretionary percentage point change in the ratio of general government balance to GDP in response to a 1 percentage point increase in real GDP including current and lagged effects.

Observations with GDP growth at or above period average.

Observations with GDP growth below period average.

Weighted average.

Figure 1.
Figure 1.

EU Countries: Cyclical Fiscal Policy Behavior

Citation: IMF Staff Country Reports 2001, 201; 10.5089/9781451812992.002.A005

Sources: European Commission; and staff estimates.1/ Automatic change in general government balance-GDP ratio in response to a 1 percentage point increase in real GDP growth.2/ Discretionary change in general government balance-GDP ratio in response to a 1 percentage point increase in real GDP growth.3/ Sum of automatic fiscal stabilizer and discretionary fiscal response coefficients.

14. Turning to the regression results that allow for different discretionary responses depending on whether output growth exceeds or falls short of average, the regression results suggest that procyclical behavior is overwhelmingly a characteristic of high-growth episodes (Table 2). In fact, the results for only one EU country (Finland) suggest that discretionary fiscal policy responded countercyclically during high-growth episodes (Figure 2). By contrast, during low-growth episodes, procyclical responses appear to be either subdued or discretionary fiscal policy even pursued a pronounced countercyclical stance (France, Denmark, and Sweden).

Figure 2.
Figure 2.

EU Countries: Discretionary Fiscal Policy Responses In Different GDP Growth Regimes

Citation: IMF Staff Country Reports 2001, 201; 10.5089/9781451812992.002.A005

Sources: Table 2; and staff estimates.

15. Finally, to shed light on the intra-year fiscal policy response to GDP growth surprises, regression (7) was run for selected EU countries (Table 3). The regressions use forecast errors based on one-year-ahead (December) OECD forecasts spanning 1978-2000 (for the major industrial countries) or 1983-2000 (for all other countries). The results indicate that countries that are prone to strong procyclical behavior (as indicated by the results in Table 2) are also prone to offsetting automatic fiscal stabilizers in response to GDP growth surprises. However, regressions that allow for asymmetric responses to negative and positive forecast errors for GDP growth (not reported) suggest that procyclical behavior is largely concentrated in years with positive GDP growth surprises. Put differently, countries largely allow automatic fiscal stabilizers to work in years with negative GDP growth surprises.

Table 3.

EU Countries: Estimates of Responses of OECD Forecast Errors for General Government Balance-GDP Ratio to OECD Forecast Errors for Real GDP, 1978-20001/

article image
Sources: OECD forecasts from OECD Economic Outlook, December, consecutive issues; and. staff estimates.

Time range for Austria, Belgium, Finland, and Netherlands is 1983-2000.

Estimate of combined coefficient in equation (7).

Automatic stabilizer coefficient (current) from Table 1.

Calculated as difference between automatic stabilizer coefficent and combined response.

16. In four cases (United States, Japan, United Kingdom, and Sweden) the estimated intra-year fiscal policy responses have a positive sign, pointing prima facie to anticyclical fiscal policy actions to growth surprises. However, while this finding could indeed be due to unusually quick anticyclical policy action in these countries, a more plausible alternative explanation might be that the finding reflects underestimation of the size of automatic fiscal stabilizers in countries that have experienced asset price cycles over the last two decades. The latter interpretation would be consistent with work by Eschenbach and Schuknecht (2001), who find in case study for Sweden that asset price cycles may have boosted automatic fiscal stabilizers far above the conventional estimates reported in Table 1.

D. Past Cyclical Fiscal Policy Behavior: Cross-Country Evidence

17. While procyclical fiscal policy behavior appears to characterize the fiscal data of most EU countries, the previous section’s analysis also highlights the considerable heterogeneity in cyclical fiscal policy behavior across countries. What factors or institutional arrangements could explain these cross-country differences? Following loosely in the footsteps of recent literature on the roots of European unemployment,11 it is useful to think about fiscal policy behavior as the outcome of the interaction between fiscal institutions (formal and informal constraints on fiscal policy behavior) and the economic environment (shocks). Assuming the economic environment during the last two decades was roughly similar across EU countries, cross-country differences in fiscal institutions should account for differences in cyclical policy behavior.

18. Three types of indicators capturing fiscal institutions that could influence fiscal policy behavior in response to output fluctuations could be of particular interest:

  • The nature of (formal or informal) constraints on the size of fiscal deficits. With lax fiscal constraints and a sizeable public debt, procyclical fiscal policy behavior could arise as a by-product of a vulnerable fiscal positions. For example, fiscal deficits may have to be contained during cyclical downswings to assuage capital markets, while there may be few (political) incentives to roll back indebtedness during cyclical expansions. The empirical analysis uses the observed levels of gross public debt (as a percent of GDP) in 2000 as a proxy of the laxity of past constraints on fiscal policy.

  • The use of pay-as-you-go (PAYG) principles to finance social security systems. For example, strict PAYG (with no transfers from other budgets) would mimic fiscal policy behavior under a strict balanced-budget rule because deviations of revenue from spending due to output growth fluctuations would have to be offset by immediate adjustments in the social contribution rate or spending measures. In the empirical analysis, the size of social security systems—as measured by social security contributions as a percent of GDP—is used as a rough proxy of the importance of PAYG financing within the general government.12

  • The degree of decentralization of the general government. Lower governments endowed with their own sources of revenue are more likely to adopt fiscal policy behavior that mimics (procyclical) balanced-budget rules than central governments, in part because shocks to output growth at the lower government level are likely to be more persistent than at the national level.13 As a proxy of the importance of fiscal decentralization, the analysis below will use the size of the local government sector as measured by total spending (as a percent of GDP).

19. The cross-section evidence on the degree of procyclical behavior (proxied by the estimates of fiscal offset coefficients reported in Table 2) and the level of gross public debt in 2000 is summarized in the first panel of Figure 3. Among EU countries, three cases that combine strongly procyclical behavior with high debt levels stand out: Italy, Belgium, and Greece. At the same time, lower levels of gross debt in the range of 40-60 percent of GDP appear to be compatible with a rather wide range of cyclical fiscal policy behavior. Thus, this cursory cross-country evidence appears to suggest that while lax fiscal institutions appear to be a sufficient condition for procyclical fiscal policy behavior, this type of behavior may as well arise under fiscal institutions that put relatively tight limits on public debt accumulation. For example, among euro area countries, Germany, Austria, and the Netherlands appear to have, over the last two decades, adopted a de facto culture of targeting nominal deficits—reflected in procyclical behavior and low variability of fiscal positions (in Germany’s case notwithstanding the large fiscal shock of unification).

Figure 3.
Figure 3.

EU Countries: Cross-Country Evidence on Cyclical Fiscal Policy Behavior

Citation: IMF Staff Country Reports 2001, 201; 10.5089/9781451812992.002.A005

Sources: IMF Government Finance Statistics (2000); European Commission; and staff estimates.1/ Measured by social contributions as a percent of GDP.2/ Spending by local governments as a percent of GDP.3/ Trendline excludes Denmark, Finland, and Sweden.

20. The cross-country evidence on procyclical fiscal policy behavior and the size of the PAYG social insurance system suggests that larger-sized PAYG systems are indeed associated with more pronounced procyclical fiscal policy behavior (middle panel in Figure 3). Box 1 contains a case study of PAYG financing of social insurance in Germany and its impact on the cyclical behavior of Germany’s fiscal policy; the box also illustrates the option of cyclical reserve funding of social insurance to avoid the straightjacket constraints of PAYG financing.

21. Perhaps contrary to conventional wisdom, the cross-country evidence for all EU countries summarized in the bottom panel of Figure 3. suggests that large local government sectors need not necessarily be associated with an increased tendency to procyclical fiscal policy behavior. However, this result appears to largely reflect the rather unique status of the Scandinavian EU member countries—Denmark, Finland, and Sweden—all of which have relatively large lower government sectors that appear not to have stood in the way of allowing free play to automatic fiscal stabilizers, perhaps reflecting the structure of intergovernmental transfer systems. Excluding the Scandinavian countries from the crosscountry sample produces the (expected) downward sloping relationship—countries are more prone to procyclical policy behavior the larger the size of the lower government sector.

E. Will the SGP Help Overcome Procyclical Behavior?

22. Views on how to ensure simultaneously fiscal discipline and a meaningful stabilization role for fiscal policy are evolving. A succinct summary in terms of the framework in Section 2 and taking account of different types of shocks could run as follows:

  • Biases in the political process require tight constraints on the term (Abut) to keep the underlying balance position in “sustainable territory.” The Maastricht Treaty’s precepts for avoiding excessive fiscal deficits—further fleshed out in the Stability and Growth Pact (SGP)—squarely aim at preventing backsliding on fiscal probity. In particular, the SGP obliges member states to reach and “… adhere to the medium-term objective of budgetary positions close to balance or in surplus.”14

  • In response to “normally-sized” demand shocks (i.e. transitory shocks to the level of output) where the sources of shocks are difficult to identify, the automatic fiscal stabilizers should be allowed to operate fully and symmetrically, i.e. β = β+ = β- = 0. In this context, the SGP states that reaching the medium-term balance objective would “… allow member states to deal with normal cyclical fluctuations while keeping the government deficit within the 3 percent of GDP reference value”15

  • In response to “large-sized” demand shocks where the sources of shocks represent readily identifiable events, the automatic fiscal stabilizers should probably be reinforced by specific policies that would be reflected in positive values for β (if serious concerns about debt dynamics do not argue otherwise).16

  • In the case of supply shocks (i.e. permanent shocks that affect the long-run level of output), the automatic fiscal stabilizers should be offset by allowing for negative values of β. In the case of supply shocks, the operation of automatic fiscal stabilizers is not desirable because they get in the way of the needed adjustment of actual output to the new level of potential output. It is noteworthy that disentangling demand and supply shocks is difficult, particularly in the short run.

23. In sum, the SGP squarely addresses the need to constrain fiscal policy while leaving flexibility to stabilize demand-side driven output fluctuations. However, the SGP leaves unclear what countries should do if they have not reached their medium-term balance objectives and are faced with a sharp unexpected growth slowdown—the present situation in the three largest euro-area members (Germany, France, and Italy). Policy makers in the EU have generally adopted the view that SGP-delinquent countries should be held to the nominal balance (as a percent of GDP) targets contained in the Stability Programs (SPs). If growth slows unexpectedly, this view would call for procyclical spending or revenue adjustments in these countries. An alternative view would try to safeguard the operation of automatic fiscal stabilizers on the revenue side and allow balances to adjust to growth surprises. At the same time, countries could be held accountable for reaching the nominal spending paths laid out in their SPs to ensure that countries stay on the transition paths to their medium-term balance objectives.

24. Making the SGP work in the sense of preserving the functioning of automatic fiscal stabilizers may also require institutional reforms. The empirical evidence presented in this chapter points to two features of fiscal systems in many EU countries that should receive some attention. First, it might be useful to examine the option of setting up reserve funds that allow for more cyclical variation in social insurance funds’ fiscal position—with the idea of providing (cyclical) breathing space from the straightjacket rule of PAYG financing. Second, in countries with large local government sectors, there may be ways to coordinate better fiscal policy behavior across different government units without cutting into the benefits of fiscal decentralization. But reforms of long-standing fiscal institutions are likely to be difficult—with many devils hiding in the details. However, a more cycle friendly fiscal policy would provide EMU with a much-needed stabilization mechanism, particularly when the area is hit by large common demand shocks.

Germany’s PAYG System and Procyclical Behavior

In 2000, spending by Germany’s social insurance sector—which covers pensions, health care, long-term care, and unemployment insurance-amounted to 21.4 percent of GDP, accounting for about 45 percent of total general government spending (excluding UMTS receipts). Social insurance is overwhelmingly financed by social security contributions—yielding some 18 percent of GDP—while the remainder reflects budget transfers to the social insurance sector. In view of its size, social insurance accounts for a significant portion of the general government’s automatic fiscal stabilizers. Assuming an elasticity of social contributions with respect to output growth of 0.7 and taking account of the automatic countercyclical behavior of unemployment benefits, the current automatic response of the social insurance balance should be about 0.20 and the lagged automatic response should be around 0.05. Thus, with an overall automatic response estimate of 0.25, the social insurance system should account for almost half of the automatic fiscal stabilizers of Germany’s general government sector (0.55).

However, in practice the social insurance system is financed based on rules that closely approximate the pay-as-you-go (PAYG) principle. For example, in the case of public pensions, there is an automatic feedback in place to finance shortfalls in overall pension finances (which was formalized by the 1992 Pension Reform Act) through a mixture of increases in contribution rates, slower adjustment of pension payouts, and increased transfers from the federal government. Although the public pension fund maintains a liquid fluctuation reserve, this reserve is not used to smooth cyclical fluctuations in pension revenue.

Turning to the time series evidence, the PAYG nature of Germany’s financing of social insurance is well illustrated by plots of the change in the balance of the social insurance system and the real GDP growth rate (adjusted for drift) during 1971-2000 (see Box 1 Figure 1, first panel). A marked response of the social insurance balance to the fluctuations in GDP growth can only be detected during the recession triggered by the first oil shock. Regressing the change in the social insurance balance (Δbsoct) on current and lagged real GDP growth during 1978-2000 gives (with t-statistics in parentheses):

Δbsoct=−0.02(0.39)[Δyt−μ]+0.01(0.26)[Δyt-1−μ]R2=0.01DW=2.03

The estimated response coefficients are close to zero, consistent with the PAYG financing principle.

The second panel of Box 1 Figure 1 presents the results of a counterfactual experiment, where the social insurance funds accumulate and run down a cyclical reserve fund that fully accommodates the automatic fiscal stabilizers during 1971-2000. This counterfactual experiment suggests that such a reserve fund would need to be able to accommodate swings in social insurance finances amounting to some 3 percent of GDP.

Box 1 Figure 1.
Box 1 Figure 1.

Germany; Social Insurance Finances

Citation: IMF Staff Country Reports 2001, 201; 10.5089/9781451812992.002.A005

Sources: WEO database; and staff estimates.1/ In percent of G3P.

References

  • Blanchard, Olivier J., 1990, “Suggestions for a New Set of Fiscal Indicators” OECD Working Papers No. 79.

  • Blanchard, Olivier J., and Lawrence Katz, 1992, “Regional Evolutions,” Brookings Papers in Economic Activity, pp. 1–75.

  • Blanchard, Olivier J., and Mark W. Watson, 1986, “Are Business Cycles All Alike?” in: Robert J. Gordon, The American Business Cycle: Continuity and Change, NBER Studies in Business Cycles Vol. 25., University of Chicago Press.

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  • Blanchard, Olivier J., and Justin Wolfers, 1999, “The Role of Shocks and Institutions in the Rise of European Unemployment: The Aggregate Evidence,” (mimeo.).

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  • Chouraqui, Jean-Claude, Hagemann, Robert P., and Nicola Sartor, 1990, “Indicators of Fiscal Policy: A Reassessment,” OECD Working Paper No. 78.

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  • Eschenbach, Felix, and Ludger Schuknecht, 2001, “Fiscal Risks and Asset Price Cycles: Conceptual Issues and the Case of Sweden,” (mimeo.)

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  • European Commission, 2000, Public Finances in EMU—2000, European Economy No. 3.

  • European Commission, 2001, Public Finances in EMU—2001, European Economy No. 3.

  • IMF, 1998a, “Fiscal Stabilization and Policy under EMU,” Chapter I in: Germany—Selected Issues and Statistical Appendix.

  • IMF, 1998b, “Fiscal Policy and the Business Cycle,” Chapter II in: Switzerland—Selected Issues and Statistical Appendix.

  • Van den Noord, Paul, 2000, “The Size and Role of Automatic Fiscal Stabilizers,” OECD Working Paper.

1

Prepared by Albert Jaeger (Ajaeger@imf.org).

2

A separate background paper on Rules-Based Fiscal Policy and the Fiscal Framework in France, Germany, Italy, and Spain discusses fiscal management and rules in the largest euro area countries. In-depth discussions of SGP rules and evolving surveillance under the SGP can be found in European Commission (2000, 2001).

3

To simplify the exposition, α is assumed to combine current as well as lagged responses.

4

It is noteworthy that the interpretation of the “structural budget balance” as the “budgetary position that would be observed if the levels of actual and potential output coincided” relies on the implicit assumption that 13 is zero. For example, in the case of procyclical responses (β<0) the structural balance overstates the soundness of the underlying fiscal position in the case of a negative output gap.

5

Tests for autocorrelation in the error term suggested that this assumption is appropriate for most regressions. In principle, (Abut) could be modeled as a more general ARMA process to capture any serial autocorrelation.

6

There is a break in EU countries’ fiscal data in 1995 due to the adoption of the European System of Accounts (ESA). The regressions below use first-differenced data for 1978-95, which are based on the pre-ESA data, and first-differenced data for 1996-00 based on ESA. The fiscal data for 2000 in the regressions exclude UMTS license receipts in the case of Germany, Spain, Italy, the Netherlands, Austria, and the United Kingdom. Luxembourg’s general government data for 1988-89 represent staff estimates.

7

In the case of Germany, formal econometric tests support the hypothesis of a structural break in cyclical fiscal policy behavior in 1978. See IMF (1998a, p. 24).

8

The automatic revenue responses draw largely on OECD work on revenue elasticities in industrial countries, see Chouraqui et. al. (1990) and Van den Noord (2000). The European Commission’s estimates of automatic fiscal stabilizers also draw on OECD work.

9

The HP smoothing constant was fixed at 400.

10

Replacing the balance by the primary balance-GDP ratio-thus excluding interest payments on debt-does not materially affect the regression results.

12

Social contributions as a measure of the size of PAYG systems are likely to be unsatisfactory in some cases. For example, the financing of Luxembourg’s social insurance system is based on smoothing social contribution rates over a seven-year horizon, and financing shortfalls or surpluses are reflected in social insurance reserve funds.

13

See Blanchard and Katz (1992) for a study finding high persistence of regional growth fluctuations in the United States.

14

EC Council Regulation No. 1466/97 of July 7, 1997.

15

EC Council Regulation No. 1466/97 of July 7, 1997.

16

The distinction between “normally-sized” and “large-sized” shocks and their implications for macroeconomic stabilization policies is discussed in Blanchard and Watson (1986).

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Cover IMF Staff Country Reports
Monetary and Exchange Rate Policies of the Euro Area: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 2001: Issue 201
Publisher:
International Monetary Fund
ISBN:
9781451812992
ISSN:
1934-7685
Pages:
99
DOI:
https://doi.org/10.5089/9781451812992.002

EU Countries: Cyclical Fiscal Policy Behavior

EU Countries: Discretionary Fiscal Policy Responses In Different GDP Growth Regimes

EU Countries: Cross-Country Evidence on Cyclical Fiscal Policy Behavior

Germany; Social Insurance Finances