Fiscal Policy Rules in Practice

Abstract

This paper analyzes German and Spanish fiscal policy using simple policy rules. We choose Germany and Spain, as both are Member States in the European Monetary Union (EMU) and underwent considerable increases in public debt in the early 1990s. We focus on the question, how fiscal policy behaves under rising public debt ratios. It is found that both Germany and Spain generally exhibit a positive relationship between government revenues and debt. Using Markov-switching techniques, we show that both countries underwent a change in policy behavior in the light of rising debt/output ratios at the end of the 1990s. Interestingly, this change in policy behavior differs in its characteristics across the two countries and seems to be non-permanent in the case of Germany.

Revisitando a função de reação fiscal no Brasil pós-Real: uma abordagem de mudanças de regime

“…Ainda que relativamente menor, uma literatura análoga surgiu com a preocupação de estimar a "função de reação fiscal" dos Tesouros Nacionais (BohN, 1998;TAylor, 2000;PeroTTi, 2003;ThAmS, 2007).…”

Do House Prices in Turkey Follow Euro Area Trends?: Regime Switching Approach

“…Lagged House Price Index is added into models to avoid both economic and econometric problems. Otherwise, endogeneity problems may be encountered in Markov estimates (Thams, 2007…”

Fiscal Regimes in Spain: A Markov-Switching Approach

“…Among the advantages of policy rules are their simple specification, their potential to differentiate between discretionary and rule-based policy behavior and their use as a benchmark for policy evaluation (Thams, 2007). Nevertheless, their main disadvantage follows from one of their benefits: their simplicity may not be adequate to deal with complex situations like the current international economic crisis.…”

“…Within the second strand of Markov-Switching regression papers, Thams (2007) investigate the relationship between fiscal instruments and public debt for Germany (1970Q1-2003Q4) and Spain (1986Q1-2003Q4). He finds that both Germany and Spain generally exhibit a positive relationship between government revenues and debt, and that both countries changed their policy behavior at the end of the nineties because of rising debt-to-GDP ratios.…”

“…According to Thams (2007), the inclusion of the lagged debt-to-GDP ratio is compulsory for econometric and economic reasons: on the one hand, there would be an endogeneity problem if the current debt-to-GDP ratio were considered and, on the other hand, it would be difficult to empirically detect a contemporaneous reaction of fiscal policy to changes in public debt because of implementation lags. Referring to the optimal taxation theory by Barro (1984), the incorporation of the expenditure gap is based on the fact that temporary rises of government expenditure do not compromise debt stabilization, and the inclusion of the output gap is justified on the grounds that fiscal policy usually follows a countercyclical motive.…”