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Trust in government and fiscal adjustments

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Abstract

The paper looks at the determinants of fiscal adjustments as reflected in the primary surplus of countries. Our conjecture is that governments will usually find it more attractive to pursue fiscal adjustments in a situation of relatively high growth, but based on a simple stylized model of government behavior, the expectation is that mainly high-trust governments will be in a position to defer consolidation to years with higher growth. Overall, our analysis of a panel of European countries provides support for this expectation. The difference in fiscal policies depending on government trust levels may help explaining why better governed countries have been found to have less severe business cycles. It suggests that trust and credibility play an important role not only in monetary policy, but also in fiscal policy.

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Notes

  1. See Alesina et al. (2008) for a related argument.

  2. In contrast to earlier sustainability tests (see, for instance, Wilcox 1989; Kremers 1989; Haug 1990; Hakkio and Rush 1991; Trehan and Walsh 1991), the MBSA does not require assumptions about the appropriate discount factor. In addition, the MBSA lacks information requirements on debt structure or the design of fiscal policy.

  3. A Hodrick–Prescott filter with a standard annual smoothing parameter of \(\lambda =100\) has been applied.

  4. Since Eurobarometer surveys related to trust in government are unavailable before 1999, lagged values imply somewhat smaller samples than those described in Table 2.

  5. We are grateful to an anonymous referee for pointing out this possibility.

  6. In the case of Germany, for example, the introduction of the new debt brake in 2009 was connected to a stimulus program during the financial crisis and therefore was not completely exogenous.

  7. We may also mention that inclusion of the FRI variable does not change the insignificance of the first-stage residuals in the control function approach.

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Acknowledgments

We thank Monika Bütler, Jeremy Edwards, Robert Krämer, two anonymous referees, and seminar participants at the ECB, the IMF, the University of Calgary, McMaster University, the Annual Congress of the International Institute of Public Finance, and the Annual Congress of the German Economic Association for very helpful comments. The paper is part of the research program of the Center “Sustainable Architecture for Finance in Europe” (S A F E). Parts of this work were carried out while Bursian and Zimmer were PhD students at Goethe University Frankfurt. The opinions expressed in this paper are those of the authors and do not necessarily reflect the views of the Deutsche Bundesbank.

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Correspondence to Alfons J. Weichenrieder.

Appendix

Appendix

See Tables 7, 8, 9 and 10.

Table 7 Average level of trust in national governments
Table 8 Simple fiscal reaction functions (euro area)
Table 9 Fiscal reaction functions with double lagged levels of government trust
Table 10 First-stage regressions of the control function approach

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Bursian, D., Weichenrieder, A.J. & Zimmer, J. Trust in government and fiscal adjustments. Int Tax Public Finance 22, 663–682 (2015). https://doi.org/10.1007/s10797-015-9363-2

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