Appraising the Effects of the Budget on the Economy with an Econometric Model: The Italian Fiscal Adjustment in the Nineties
48 Pages Posted: 28 Jun 2012
Date Written: June 27, 2012
This paper describes a procedure for assessing the effects of the budget on economic activity in the short term. Based on counterfactual simulations of an econometric model, the procedure takes into account more relationships between the budget and the economy than other, more synthetic indicators. It not only measures the impact of the budget on output but also evaluates how the budget affects prices and other macroeconomic variables. Moreover, the procedure provides estimates of the effects of specific features of the budget, such as its composition.
The procedure is used to appraise the impact of the budget on the Italian economy in the period 1991-2000, using the Bank of Italy’s Quarterly Econometric Model. During the period of fiscal consolidation (1991-97), the impact on GDP growth was generally negative, averaging about -0.6 percentage points (with a spike of -1.4 points in 1995). As fiscal policy relaxed once Italy had succeeded in joining the Monetary Union, the impact on output growth became slightly positive, as in 1998 and 1999, or neutral, as in 2000. Even within the generally restrictive context, the budget exerted a mildly counter-cyclical influence. This result is in line with the findings of previous literature for the 1970s and 1980s.
The composition of the budget often played a significant role, in some years amplifying the impact on the primary deficit, in others reducing or even offsetting it. In the period 1991-97, changes in the composition substantially increased the costs of fiscal adjustment. The average impact of the budget on inflation was basically nil in the decade.
The results appear significantly different, both quantitatively and qualitatively, from those obtained using the synthetic budget indicators commonly used to assess the fiscal stance.
Lastly, a number of additional experiments assess the sensitivity to changes in some key assumptions. In particular, a forward-looking specification of consumers’ behaviour and a forward-looking Taylor-type monetary policy reaction function were estimated and used in the counterfactual simulations. Neither results in significant modifications in the paper’s main conclusions.
Keywords: government budget, fiscal adjustment, econometric model
JEL Classification: E62, E65
Suggested Citation: Suggested Citation