The Cyclical Response of Fiscal Policies in the Euro Area – Why Do Results of Empirical Research Differ so Strongly?
34 Pages Posted: 14 Feb 2012
Date Written: March 29, 2007
Whether discretionary fiscal policies in industrialized countries act counter- or pro-cyclically and whether their reaction is symmetric or asymmetric over the cycle are still largely unsettled questions. This uncertainty perdures when attention is restricted to euro-area countries, where these questions have important implications for the debate on European fiscal rules. We review the most recent empirical literature on these issues to try to understand why the results of the various studies differ so strongly. We find that differences are partly driven by the choices made in modelling fiscal behaviour. Results are also affected by a technical decision (whether or not controlling for common factors with time dummies) and by the selection of the data source and its vintage (ex post and real-time information). The choice of the time period seems relatively less important but we observe, contrary to other findings, a tendency towards pro-cyclicality when the sample moves forward, excluding the most distant years and including the most recent ones. Overall, we conclude that, with ex post information, the notion of pro-cyclical fiscal policies often upheld in the debate is not justified by the data, which tend to suggest either a-cyclicality or weak counter-cyclicality. If we use real-time information, we find clearer indications of counter-cyclical behaviour, especially if we progress from a very simplified “core” model to a more complex one, including at least the impact of fiscal rules. As for symmetry or asymmetry, we find that the answer varies across sources of data and time periods. When we move to a more complex model, indications of asymmetric behaviour are more robust. Whenever asymmetry is present, it entails shifts in all the parameters of the fiscal rule and not necessarily in the output gap parameter.
Keywords: fiscal policy, euro-area countries, fiscal rules, pro- and counter-cyclical policies, policy symmetry over the cycle, ex post and real-time data, dynamic panel models
JEL Classification: E61, D72, E62, H60
Suggested Citation: Suggested Citation