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Fiscal policy response to cycles under two regimes: Spain 1950–1998

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Abstract

In the second half of the 20th century, Spain provides a case of political regime change, which according to some political economy models should also lead to a shift in the cyclical nature of fiscal policy. We find that in most of the pre-democratic era, there was a strong procyclical bias to fiscal policy. Eradication began in the last years of the autocratic regime under the influence of fiscal institutional reform and perhaps learning. It was completed after the transition to democracy when countercyclical fiscal policy was reinforced in the late 1980s by membership of the European Exchange Rate Mechanism. This experience, established by two separate econometric identification procedures, as well as a narrative drawing especially upon OECD and EIU reports, runs counter to the predictions of the political economy models of Lane (J Public Econ 87(12):2661–2675, 2003) and Alesina et al. (J Eur Econ Assoc 5:1006–1036, 2008).

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Fig. 1
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Notes

  1. 1.

    Measured by the proportion of years for which the output gap and the ‘fiscal impulse’—the improvement in the structural balance—have opposite signs.

  2. 2.

    A World Bank mission in 1962 identified over 1,600 autonomous official spending units with less than adequate reporting standards and was obliged to confine their discussion of Spanish public expenditure to central government spending, the only category for which they could obtain data (International Bank for Reconstruction and Development 1963).

  3. 3.

    In fact, after the emergency devaluations of 1976 and 1977, the Spanish governments showed a persistent ‘fear of floating’. Reinhart and Rogoff (2004) classify the Peseta exchange rate as a de facto 2 % crawling band around the Deutschmark from 1980 to 1994. Ledesma Rodríguez et al. (2005) also find that a de facto peg to the Deutschmark prevailed between 1978 and 1984, and again between 1986 and the 1993 crisis, and was temporarily abandoned only in 1985 in response to speculative attacks in the wake of Spain’s accession to the EEC. These results strongly suggest that Spanish monetary authorities worried about the pass-through from exchange rates to prices and systematically intervened to smooth fluctuations in the nominal exchange rate, even in the absence of a formal commitment to peg.

  4. 4.

    Recent studies suggest that the stabilizing effect of government size may have significantly declined since the 1980s (Mohanty and Zampolli 2009). The latter evidence is consistent with the decline of fiscal multipliers observed by Perotti (2005).

  5. 5.

    There has been some theorising about the effects of fiscal policy shocks under normative fiscal rules (summarised by Daban et al. 2003) but the reaction functions investigated here are not announced rules.

  6. 6.

    Also, a common finding of empirical economic growth models is that government consumption has a negative impact whereas education, often largely financed by the state, has a positive impact. For example, in Barro (1997), these two effects virtually offset each other.

  7. 7.

    However, estimates of potential or trend output, as well as the systematic distortions introduced by estimated tax and spending elasticities in the cyclically adjusted balances, are also controversial issues (Alberola et al. 2003; Mohr and Morris 2007).

  8. 8.

    In the case of a cyclical fiscal policy with constant tax rate and government expenditure, tax revenues and the primary balance are positively correlated with the cycle, but the GDP ratio of government expenditure is negatively correlated with the cycle, and the correlation of the GDP ratio of tax revenues is ambiguous, as it also turns the GDP ratio of primary balance. With procyclical fiscal policy (identified by falling tax rate and increasing expenditure in good times), the correlation of tax revenues and their GDP ratio with the cycle is ambiguous (the tax rate falls but the tax base increases) and the same happens to the GDP ratio of the primary balance.

  9. 9.

    The share of the industrial and constructions sector on total GDP at current prices hovered around 35 % for the whole period 1952–1986. Its contribution to real GDP growth decreased from 50 to 55 % in 1952–1974 to ca. 33 % in the late 1980s (Prados de la Escosura 2003, pp. 203–205). We prefer the industrial production index reported by INE (Instituto Nacional de Estadística) and international organizations such as the IMF (see Appendix for details) to the historical series of real GDP and industrial production reconstructed by Prados de la Escosura since the former was observable by the government and economic agents and is also comparable with industrial production indices of other European countries reported by the IMF.

  10. 10.

    As Kaminsky et al. (2004) note, only if a negative c(5) parameter is obtained can a procyclical discretionary tax policy be identified. A positive coefficient is unable to discriminate between procyclical or countercyclical behaviour. So we need to only find that c(5) is not negative after 1976 to corroborate the hypothesis of countercyclicality under democracy.

  11. 11.

    As a robustness check, we also estimate the reaction function under the alternative specification, that is, assuming that revenues decisions come first, which formally implies imposing c(2) = 0. Results do not change. They are not reported in order to save space but are available upon request.

  12. 12.

    Rigobon (2004) demonstrates that, assuming two countries with the same procyclical fiscal policy and standard Keynesian effects on output but different types of shocks, OLS estimates would lead to observe a procyclical fiscal policy in the country where fiscal shocks dominate on output shocks.

  13. 13.

    A similar approach is adopted by Jaimovich and Panizza (2007). Our instrumental variable is a weighted industrial production index of five ‘core’ European economies (France, West Germany, the Netherlands, Belgium and the UK). The first stage regression has good explanatory power (R 2 0.47) with coefficients and t-stats: 0.622 (2.56**) and 0.768 (4.01***) of contemporaneous and lagged foreign output growth, respectively. Unit root tests confirm that the series are stationary. Autoregressive lags are selected on the base of standard (Akaike and Schwartz) criteria.

  14. 14.

    Election year dummies are specified as 1 in the four quarters prior to a general election (including the quarter in which the election took place). We test for political budget cycles only using quarterly data because most Spanish elections were held in the first half of the year, so that an annual dummy would capture both pre- and post-election fiscal shocks. An additional problem with annual dummies is the limited number of observations and the absence of sufficient degrees of freedom.

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Acknowledgments

The authors are grateful for their useful comments and suggestions to anonymous referees and to participants in the Third Iberometrics Conference (Valencia), the European Historical Economics Society Conference (Lund), the XVIII Meeting of Public Economics (Malaga), where previous drafts of this research were presented. Battilossi acknowledges the financial support of the Spanish MICINN through projects ECO2008-02089 and ECO2011-25713, and the generous hospitality of the Department of Economic History at the LSE, where he spent a semester in 2010 as a Senior Visiting Fellow. Escario acknowledges financial support from the Spanish MICINN through project ECO2009-08204, the ‘Programa Europa XXI para estancias de investigación del Gobierno de Aragón y la Caja Inmaculada’, and Grupo de Excelencia de Investigación SEIM (SEC 269–124). The usual disclaimer of responsibility for remaining errors and omissions applies.

Author information

Correspondence to James Foreman-Peck.

Appendix: Data and sources

Appendix: Data and sources

Fiscal variables

Annual

Estadísticas Históricas de España. Siglos XIXXX, A. Carreras, X. Tafunell, eds. (Fundación BBVA, 2005), c. 12, F. Comín, D. Diaz, ‘Sector público administrativo y estado del bienestar’, vol. II, pp. 873–964

Central government tax revenues:

  • 1950–1961, Table 12.16 ‘Ingresos del Estado: clasificación económica’, p. 940 [includes indirect and direct tax revenue, monopolies, other current revenue (transfers among public administrations and other current transfers), capital tax revenues].

  • 1962–1998, Table 12.21 ‘Estado: ingresos corrientes y de capital (movimiento de caja), clasificación económica’, p. 948 [includes indirect and direct tax revenue, current and capital transfers, interest revenue, dividends and other]. This series corresponds to the data reported in IMF International Financial Statistics, ‘Total revenue and grants’, ifs:s18481y.zf.

Central government expenditures:

  • 1950–1961, Table 12.17 ‘Gastos del Estado: clasificación económica’, p. 943.

  • 1962–1998, Table 12.22 ‘Estado: gastos corrientes y de capital (movimiento de caja), clasificación económica’, p. 949 [includes wages, purchases, current and capital transfers, investment, interest payments and other expenditures]. This series corresponds (with minor discrepancies) to the data reported in IMF International Financial Statistics, ‘Expenditures’ (net of lending and repayments), ifs:s18482zfa.

  • Social security: 1958–1998, Table 12.31 ‘Cuentas de la Seguridad Social’, pp. 958–959

  • Government debt: 1950–1998, Table 12.34 ‘Deuda pública en circulación’, pp. 962–963.

Quarterly

IMF International Financial Statistics

  • Central government tax revenues (1962Q1–1998Q4): ifs: s18481zfq

  • Central government expenditures (1962Q1–1998Q4): ifs: s18482zfq

  • Government debt (1958Q3–1998Q4): ifs: s18488zfq

Wholesale Price Index

Annual

IMF International Financial Statistics (1950–1998): ifs: s18463zf

Quarterly

IMF International Financial Statistics (1959Q1–1998Q4): ifs: s18463zfq

Industrial Production Index

Annual

Spain (1950–1998): Estadísticas Históricas de España. Siglos XIXXX, A. Carreras, X. Tafunell, eds. (Fundación BBVA, 2005), c. 5, A. Carreras, ‘Industria’, vol. I, pp. 357–964, Table 5.11 ‘Índices de la producción industrial’, Series INE (Instituto Nacional de Estadística). This series tracks (with minor discrepancies) the industrial production index (s.a.) reported from 1960 by IMF International Financial Statistics, ifs: s18466czfa.

France, Germany, the Netherlands, Belgium and UK (1950–1998): IMF International Financial Statistics, ifs: s13266czf, s13466czf, s13866czf, s12466bzf, s11266czf, respectively.

Quarterly

Spain: IMF International Financial Statistics (1961Q1–1998Q4): ifs: s18466czfq

France, Germany, the Netherlands, Belgium and UK (1957Q1–1998Q4): IMF International Financial Statistics, s13266czfq, s13466czfq, s13866czfq, s12466bzfq, s11266czfq, respectively.

GDP

Annual

Spain (1950–1998): Prados de la Escosura L. (2003).

France, Germany, the Netherlands, Belgium and UK (1950–1998): The Conference Board Total Economy Database, http://www.conference-board.org/data/economydatabase/

SOURCES

EIU = The Economist Intelligence Unit, Quarterly Economic Reviews: Spain OECD = OECD Economic Surveys: Spain

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Battilossi, S., Escario, R. & Foreman-Peck, J. Fiscal policy response to cycles under two regimes: Spain 1950–1998. Cliometrica 7, 267–294 (2013). https://doi.org/10.1007/s11698-012-0089-4

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Keywords

  • Fiscal policy
  • Business cycle
  • Regime change

JEL Classification

  • E32
  • E62
  • N14