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Fiscal regime shifts in Portugal

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Abstract

We estimate changes in fiscal policy regimes in Portugal with a Markov Switching regression of fiscal policy rules for the period 1978–2007, using a new dataset of fiscal quarterly series. We find evidence of a deficit bias, while repeated reversals of taxes making the budget procyclical. Economic booms have typically been used to relax tax pressure, especially during elections. One-off measures have been preferred over structural ones to contain the deficit during economic crises. The EU fiscal framework prompted temporary consolidation, but did not permanently change the budgeting process.

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Notes

  1. A detailed description is provided in the Appendix.

  2. Note that a passive rule is not uniquely defined from the data generating process for surpluses and debt, and is observationally equivalent to an off-equilibrium behaviour that is consistent with active fiscal policies (Cochrane 1998).

  3. A more than proportional reaction of θ (for κ = 0), or a large surplus κ > 0 (for θ = 0) imply strong sustainability as the government would keep accumulating assets. Strictly speaking, both situations imply a violation of the budget constraint, but do not create problems for sustainability of debt.

  4. We take as an output measure the HP filtered output gap.

  5. There are a few examples in the literature of regime switching tests of fiscal behaviour on US data. Davig (2004) examines the time varying probability of high and low debt regimes; Favero and Monacelli (2005) test a fiscal rule similar to (6). EU studies are fewer: Thams (2006) estimates fiscal rules for Germany and Spain; Claeys (2008) does so for Sweden.

  6. All computations are done in MSVAR for Ox (Krolzig 1998).

  7. The total number of observations in each regime is calculated as the sum of the number of quarters times the probability of the regime in that quarter.

  8. Afonso and Claeys (2008) show that fiscal policy indeed contributes much more to the variance in output developments in Portugal than in other EU countries.

  9. Note that if we do not allow for a change in volatility, the estimated coefficients of the AR model are not stable and the switches are randomly distributed over the sample period.

  10. Results not reported, but available on request.

  11. As in Davig (2004), we also estimate an AR(4) model for the debt ratio. As debt is a non-stationary series, the regime estimates are not stable. This confirms our previous finding that fiscal policy is active.

  12. This model takes large fluctuations in tax bases as exogenous.

  13. The results are not reported, but are available upon request.

  14. These data come from Warwick (1994), Laver and Hunt (1992), and Huber and Inglehart (1995).

  15. Results not reported, but they are available upon request.

  16. This is further evidence that procyclical policies are not due to falling credit ratings.

  17. See the studies by Buti and Sapir (1998), Buti et al. (1998), EC (2001), von Hagen et al. (2002), and Balassone et al. (2008).

  18. Golinelli and Momigliano (2006) argue that the findings of asymmetric procylical policies depend on the way fiscal policy is modelled. Using real time data to test fiscal rules, they find that governments genuinely react in a countercyclical and symmetric way to the cycle.

  19. For example, a specific commission—under the aegis of the Central Bank—was created in 2002 to determine the size of the 2001 budget deficit. The revised number showed a much higher deficit than previously reported, and triggered the first EDP. A similar revision in 2005 doubled the initial deficit, and set off the second EDP.

  20. Manasse (2006) finds that fiscal rules tend to reduce procyclicality if the overall quality of budget institutions is low.

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Author information

Authors and Affiliations

  1. European Central Bank, Directorate General Economics, Kaiserstraße 29, 60311, Frankfurt am Main, Germany

    António Afonso

  2. Department of Economics, ISEG/TULisbon—Technical University of Lisbon, Lisbon, Portugal

    António Afonso

  3. UECE—Research Unit on Complexity and Economics, R. Miguel Lupi 20, 1249-078, Lisbon, Portugal

    António Afonso

  4. Facultat de Econòmia i Empresa, Grup AQR IREA, Universitat de Barcelona, Avinguda Diagonal, 690, 08034, Barcelona, Spain

    Peter Claeys

  5. Department of Economics and Economic Policies Research Unit (NIPE), University of Minho, Campus of Gualtar, 4710-057, Braga, Portugal

    Ricardo M. Sousa

  6. London School of Economics, Financial Markets Group, Houghton Street, London, WC2 2AE, UK

    Ricardo M. Sousa

Authors
  1. António Afonso
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  2. Peter Claeys
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  3. Ricardo M. Sousa
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Corresponding author

Correspondence to Peter Claeys.

Additional information

The opinions expressed herein are those of the authors and do not necessarily reflect those of the ECB or the Eurosystem. We are grateful to an anonymous referee for helpful comments.

UECE is supported by FCT (Fundação para a Ciência e a Tecnologia, Portugal), financed by ERDF and Portuguese funds.

Appendix—Data description and sources

Appendix—Data description and sources

GDP:

data are quarterly, seasonally adjusted, period: 1978: 1–2007:4. Source: Bank of Portugal.

Deflator:

all variables were deflated by the GDP deflator (2000 = 100). Data are quarterly, seasonally adjusted, period: 1978:1–2007:4. Source: Bank of Portugal.

Government Spending:

defined as Central Government primary spending (on a cash basis), i.e. the difference between authorized expenditure and debt interest payments. We seasonally adjust quarterly data using Census X12 ARIMA, period 1978:1–2007:4. Source: Bank of Portugal.

Government Revenue:

defined as Central Government total revenue (on a cash basis). We seasonally adjust quarterly data using Census X12 ARIMA, period 1978:1–2007:4. Source: Bank of Portugal.

Debt:

is defined as the stock of Direct State Debt. The original series are available as follows:

  1. 1.

    for the period 1997:12–1994:6, on a quarterly basis:

    1. (a)

      total internal debt

    2. (b)

      internal direct debt

    3. (c)

      total external debt

    4. (d)

      direct external debt

    5. (e)

      total public debt

    6. (f)

      effective public debt

  2. 2.

    for the periods 1991:12, 1992:12, and 1993:6–1995:11, on a monthly basis:

    1. (a)

      internal effective direct debt

    2. (b)

      total effective direct debt

  3. 3.

    for the period 1995:7–1998:12, on a monthly basis:

    1. (a)

      internal direct debt

    2. (b)

      total direct debt

  4. 4.

    for the period 1998:12–2008:4, on a monthly basis:

    1. (a)

      direct state debt

Source: Bank of Portugal, the Directorate-General of Treasury, and the Directorate-General of Public Credit.

We build the series for the Direct State Debt as follows:

  1. 1.

    for 1998:12–2008:4, as the series of direct state debt itself;

  2. 2.

    for 1995:7–1997:12, we use the ratio of direct state debt to total state debt in 1998:12 to back-out the series of direct state debt;

  3. 3.

    for 1993:6–1995:6, we use the ratio of total effective direct state debt to total direct state debt in the period 1995:7–1995:11 to get the series of total direct debt;

  4. 4.

    for 1977:12–1993:3, we use the ratio of (effective public debt minus non-direct debt) to total effective direct debt in the period 1993:6–1994:6 to back-out the series of total effective direct debt.

Given that the scale factors are very close to one, the time series of the Direct State Debt is smooth over time and we guarantee that there are not structural breaks. We build the quarterly series using monthly data (where available) and seasonally adjust it using Census X12 ARIMA. The constructed series comprise the period 1977:4–2007:4.

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Afonso, A., Claeys, P. & Sousa, R.M. Fiscal regime shifts in Portugal. Port Econ J 10, 83–108 (2011). https://doi.org/10.1007/s10258-010-0065-5

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