After the outbreak of the global financial crisis, some governments in the EU experienced serious fiscal problems, while others were less affected. This paper seeks to shed light on the divergent fiscal performance in the EU countries before and after the outbreak of the crisis. Fiscal reaction functions of the primary balance are estimated for different groups of EU countries using quarterly data for the pre-crisis period 2001–2008 and for the crisis period 2009–2014. The pre-crisis estimations reveal some differences in persistence and cyclical reaction between different groups of countries, but in most cases little feedback from the debt stock to the primary balance. The fiscal reaction functions of the countries that eventually developed fiscal problems do not stand out. The estimations on data from the crisis period show largely unchanged persistence and counter-cyclicality but much more feedback from the debt stock, and this applies both to the crisis countries and those less affected. In spite of large deficits and accumulation of debt, the underlying fiscal reaction has become more prudent after the outbreak of the European debt crisis.
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A semi-elasticity of e.g. 0.6 implies that an increase in the output gap of 1 % corresponds to an improvement of the fiscal balance by 0.6 percentage points of GDP. Notice that the semi-elasticities used by the European Commission to compute the cyclically adjusted balance are not directly comparable to sensitivity estimates from estimation of fiscal reaction functions, in part because the latter takes into account the persistence of the fiscal stance.
All data were downloaded on 1 August 2014 from the Eurostat database (http://epp.eurostat.ec.europa.eu/ portal/page/portal/statistics/search_database). The dataset is available from the authors upon request.
Extraordinary expenses or revenue items appear particularly large when expressed in percent of quarterly GDP.
The test statistic of the Im, Pesaran and Shin test is the average of bias-adjusted t-statistics from country-specific Augmented Dickey Fuller (ADF) tests, while the test statistics of the Fisher χ 2 tests are combinations of p-values from country-specific ADF or Phillips-Perron tests.
The four quarters 2000:1–2000:4 are used for lags of the explanatory variables.
The main difference is that the estimated cyclical dependence for the EAcris5 group which is lower when the output gap is used than when the growth rate G4Y is used, but this is arguably the result of the output gap being computed using forward-looking data.
Another means of studying the prudence or “sustainability” of fiscal policy is to test for stationarity of the debt or the fiscal balance. Cuestas et al. (2014) examine whether the global financial crisis has changed the debt dynamics in 12 euro area countries and finds that this is indeed the case except in Germany and France, the two core countries of the euro area. Cuestas and Staehr (2013) find that the fiscal balance may be stationary in most EU countries from Central and Eastern Europe, but it is characterised by numerous structural breaks.
In the annual model of Bohn (1998), an increase in the debt stock of 1 percentage point would, ceteris paribus, increase the primary balance by 0.042 percentage points the following year. In our quarterly model a similar increase of the debt stock would increase the primary balance by 0.054/4 = 0.014 percentage points the following quarter.
When the equation is estimated with country-specific coefficients of DEBT(−4), the point estimates of the coefficient are 0.102, 0.261 and 0.239 and the latter two coefficients attain statistical significance at the 10 % level or better.
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The authors would like to thank, without implicating, two anonymous referees of IEEP, Davide Furceri, Dmitry Kulikov, Jaanika Meriküll and Lenno Uusküla as well as participants in the NBS conference “Fiscal policy and coordination in Europe” and an Eesti Pank seminar for their useful comments. Staehr acknowledges support from Estonian Base Financing grant no. B617A and Estonian Target Financing grant no. SF0140059s12. The views expressed are those of the authors and not necessarily those of Eesti Pank.
Appendix A: OLS estimations
Appendix A: OLS estimations
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Baldi, G., Staehr, K. The European debt crisis and fiscal reactions in Europe 2000–2014. Int Econ Econ Policy 13, 297–317 (2016). https://doi.org/10.1007/s10368-014-0309-4
- Fiscal reaction function
- Global financial crisis
- Debt crisis
- Structural break