The Cyclical Reaction of Fiscal Policies in the Euro Area: The Role of Modelling Choices and Data Vintages*

Abstract

We survey the recent empirical literature concerning the cyclical response of fiscal policies in the euro area, finding large differences in results. We show that these differences are heavily influenced by the choices made in modelling fiscal behaviour. We make a case for the use, in assessing policies and in the EMU context, of the standard modelling choice where the discretionary reaction of fiscal policy is directly estimated. Models where the overall reaction to the cycle – which includes the effects of both discretionary actions and automatic stabilisers – is directly estimated tend to suggest either strong pro‐cyclical or strong counter‐cyclical discretionary reactions, depending on how this component is identified. Within the standard model and for the years 1994 to 2008, we show that results are significantly affected by the data vintage (ex post or real‐time). With ex post data, we find an unambiguous indication of a‐cyclicality. Using real‐time data, we find that the output gap matters. However, depending on whether we assess policy intentions or actual policies, euro‐area governments' behaviour radically changes. A plausible interpretation is that in the implementation phase, governments loosen their fiscal stance, giving in to political pressures that are proportional to the scale of the economic difficulties in bad times and the size of the ‘growth dividend’ in good times.

Fiscal policy reaction to the cycle in the OECD: pro- or counter-cyclical?

“…Golinelli and Momigliano (2009) report similar results for the euro area countries already before the adoption of the euro. Elections seem to influence (unadjusted) general government balances in other OECD countries over longer periods as well while government spending is not found to be influenced by electoral cycles (Strawczynski and Zeira, 2009).…”

“…Concerning European countries, Golinelli and Momigliano (2009) survey 20 studies focusing on euro area countries and show that there is frequent disagreement on whether fiscal policy is pro-or counter-cyclical. They design a large-scale sensitivity analysis of specifications, time coverage and data vintages and conclude that fiscal policy has been a-cyclical in the euro area.…”

Real-Time Data and Fiscal Policy Analysis: A Survey of the Literature

“…In particular, some authors have focused on how the reaction of fiscal policies to the economy as planned in real time has differed from what has been observed ex-post, based on revised data. This paper is close in spirit to the surveys by Croushore (2011) and Golinelli and Momigliano (2009). However, while the former paper covers a vast macroeconomic literature based on realtime data, it does not include papers on fiscal policy.…”

“…However, while the former paper covers a vast macroeconomic literature based on realtime data, it does not include papers on fiscal policy. Golinelli and Momigliano (2009) focus on the issue of cyclicality for euro area fiscal policies and review papers based on both ex-post and ex-ante data. The present survey does not include papers based (only) on ex-post data, but it reviews a wider literature on fiscal policy and real-time data.…”

Sovereign Default Risk in the Euro-Periphery and the Euro-Candidate Countries

“…In all, a counter-cyclical fiscal policy is likely to engender a low risk environment for consumers and investors in the long-run. However, the risk-abating goal will not be reached when fiscal expansion becomes chronic and pro-cyclical, motivated by shortterm non-economic factors, including political, populist pressures (Buti/van den Noord, 2004;Kaminsky, et al, 2004;Hallerberg/Wolff, 2006;Golinelli/Momigliano, 2009). Execution of this goal can be also distorted by the discrepancy between the policy design and implementation stages.…”