Fiscal Policy Stance in the European Union: The Impact of the Euro

Abstract

In the recent years there has been an intense discussion whether the actual behaviour of fiscal authorities is consistent with cyclical stabilization objectives. The question of the appropriate fiscal policy is gaining recognition especially for the countries of the euro area after entering the European Monetary Union (EMU). Therefore, the aim of this paper is to evaluate the activity of the fiscal policy before and after the entrance to the euro zone for each individual EMU country in 1995individual EMU country in -2010 For this purpose we will use the cyclical adjusted balance, which is the common tool used to estimate fiscal policy stance. The analysis of the cyclically adjusted balance gives an additional insight into the former activity arrangements of the fiscal policy, which contributes to gauge the ex-post estimation of the fiscal policy. On this base we can determine the causes of general government budgets imbalance in the past. Despite this fact, we should be aware of some caveats in the assessment of cyclical adjusted balance, which appear due the inconsistency in measurement of output gap and potential GDP growth. To evaluate pro-cyclical or countercyclical fiscal policy stance we compare the dynamic evaluation of the cyclically adjusted balance and output gap. Namely, changes of the cyclically adjusted balance in consecutive years indicate the orientation of fiscal policy, i.e. the fiscal impulse. By comparing the change in the cyclically adjusted balance and output gap between individual years, which indicates fluctuations in the economic cycle, it is possible to assess the orientation of fiscal policy, i.e. the fiscal position. The fiscal policy can be considered as countercyclical if it is expansive in the situation of negative output gap and restrictive in the situation, when the actual growth of GDP is above its potential rate. On the other hand, fiscal policy is characterized to be pro-cyclical if in the situation of negative output gap the government uses restrictive fiscal instruments and when the fiscal policy reacts expansionary in the situation of positive output gap, where the actual output exceeds the estimated potential GDP.In the empirical analysis we evaluate the fiscal policy stance for each country of the euro area. In the assessment of government behaviour we cover 14 countries in the [1995][1996][1997][1998][1999][2000][2001][2002][2003][2004][2005][2006][2007][2008][2009][2010] IntroductionIn the 20th century many industrial countries began to record relatively high public deficits, causing further increases in public debt and therefore a deterioration of their fiscal positions. In particular, public expenditures exceeded government revenues in most countries, which had an overall impact on the growth of public debt (Baldwin & Wyplosz, 2009). As a consequence, the need to introduce fiscal rules came to the forefront of political activity, which would constrain public expenditure and consolidate the fiscal stance in the country.The Maastricht Treaty, signed by members of the ...

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