Abstract
Ever since its inception, the EMU has been subject to controversy. The fiscal policy rules embedded in the Maastricht Treaty, and clarified in the Stability and Growth Pact (SGP), are probably the most contentious. The SGP has constantly been accused of being too rigid and of forcing procyclicality in fiscal policy. However, in an influential paper Galí and Perotti (2003) concluded that discretionary fiscal policy has actually become more countercyclical in EMU countries since the Maastricht Treaty. This paper argues that this conclusion stands up to several robustness tests using ex-post data, including the use of institutional variables, but not to the use of real-time data. Using ex-post data, there is some evidence pointing to a more countercyclical use of discretionary fiscal policy (or at least to less use of procyclical discretionary fiscal policy). However, the use of real-time data for the period 1999–2006 reveals that discretionary fiscal policy has been designed to be procyclical. Hence, the actual acyclical behaviour of discretionary fiscal policy in the period after 1999 seems to be simply the result of errors in forecasting the output gap, and not the result of a change in the intentions of policy-makers. As a result, there is no evidence to support the view that Maastricht rules have forced euro-area policy-makers to change their behaviour and design countercyclical discretionary fiscal policies.
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Notes
In order to reach a balanced panel, some missing AMECO values were carefully linked with observations from the OECD Economic Outlook database. Some cyclically adjusted fiscal data are only available for some countries several years after 1980 in the AMECO database, e.g. Greece (1988), Ireland (1995), Spain (1995) and Sweden (1993). Data on the unadjusted balances, and the (calculated) implied sensitivity to the cycle were taken from the OECD database. Using it together with the output gap from AMECO resulted in linked series. The OECD database is also the source of the US output gap estimate.
Potential output is used as a deflator of all variables, instead of actual output, to reduce endogeneity problems and to minimize the influence of current GDP on the evolution of the fiscal ratios. See Bayoumi and Masson (1995) for a similar use. The output gap is defined as the difference between current and potential output as a fraction of potential output.
The use of primary balance instead of the overall budget balance is motivated by the fact that interest payments are not under the control of the fiscal authorities, but simply reflect the evolution of the interest rate and the past accumulation of budget deficits. See also Brandner, Diebalek et al. (2006) for an application of an unobserved components model to estimate a core balance for Austria.
See Baltagi (2001).
There is however a technical caveat regarding the use of fixed effects with a lagged endogenous variable resulting in inconsistent estimators. The alternative would be to use the estimator proposed by Arellano and Bond (1991). However, the small-sample properties of such an estimator are not well understood. Moreover, as much of the focus is on the difference between the estimates of the gap coefficient between two periods, I have, as Galí and Perotti (2003: note 6) did, opted to present the results with a standard instrumental variables fixed effects estimator. Notwithstanding, Table 6 in the appendix presents some results using the Arellano and Bond estimation method.
This paper makes use of the more recent version of this database (received from the authors in January 2006 and last updated in February 2007), i.e. the version used in Mierau et al. (2007) in Public Choice.
Galí and Perotti (2003) used OECD data; here the main source of data is the AMECO database, from the European Commission.
Stage II of EMU started only in 1994, and it was clear to participants that phase III would only start on the date limit imposed by article 121 of the Treaty (1999).
The political-institutional variables of Mierau et al. (2006) are only available until 2003.
The difference between the estimates for the gap before and after Maastricht is statistically significant in all regressions.
The inclusion of an interaction term renders the output gap before Maastricht non-statistically significant. At the 10% level, discretionary fiscal policy is found to be countercyclical after Maastricht.
When controlling for institutional variables, discretionary fiscal policy after the introduction of the euro is found to be acyclical in high-deficit countries, since the positive coefficient on the gap is not statistically significant.
Moreover, there is a change in sign in the non-statistically significant coefficient on the output gap. While it is positive in the period before Maastricht, it is negative in the period after the introduction of the euro.
The regression for Portugal presents a low fit to the data.
For instance, the measure of the output gap for 2001 used in the regression was the forecast of the output gap made by the Commission services in the Spring (or Autumn) of 2000.
There are some possible explanations as to why the results of this section differ from the conclusions of Forni and Momigliano (2004): a) the time period is different (1999–2006 versus 1993–2003 in their case); b) this section does not distinguish a reaction to positive output gaps from a reaction to negative ones as the authors did; c) the authors include a dummy for Maastricht restrictions, which is not included in this estimate. To gain more insight into such possibilities, a regression was done using Forni and Momigliano (2004) real-time output gap estimate (in the “expected conditions” case) along with the rest of this paper dataset. For the period 1993–2003, used by the authors, a negative coefficient is found for the gap (signalling a countercyclical policy), yet this coefficient is not statistically significant. Furthermore, when the estimation period is restricted to the euro period (1999–2003), i.e. overlapping most of the time period of the regressions presented in this section, the estimated gap coefficient is very small and positive, and in fact not statistically significant. Hence, it appears that Forni and Momigliano’s (2004) results are possibly dependent on the sample of countries used, and on the specific time frame used. As seen earlier, fiscal policy did not behave homogenously in Europe in the post-Maastricht period. As a result, some structural breaks might have occurred in the period used by the authors (1993–2003).
For example, for France the 1999 forecast for the output gap in 2000, in the “Broad Economic Policy Guidelines”, was predicted to be -2.3%. The ex-post data, as available in the spring of 2007 forecast, pointed to a positive output gap of 2.4%, i.e. to a deviation of 4.7% of the potential GDP. For Germany, the numbers are similar (the initial forecast was -0.7% and the ex-post value is 1.3%). For Italy, the figures for 2000 are 3.1% (ex-ante) vs. 1.8% (ex-post), and for Spain -3.1% (ex-ante) vs. 2.2% (ex-post).
According to Jonung and Larch (2006), there is an even greater degree of optimism in the medium-term growth outlook in national official government’s growth projections for France, Germany, Italy and the United Kingdom. Such optimism has resulted in cyclical conditions that systematically turn out to be better than assumed at the time of presenting the budget deficit.
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Acknowledgement
The text has benefited from comments received from an anonymous referee and from António Afonso, Martin Larch, Peter Brandner, José Tavares, Alfred Sitz and other participants at the 63rd International Atlantic Economic Conference held in Madrid on 14–18 March 2007, and at the Workshop on the Sustainability of the Public Debt held at Klagenfurt University on 20 May 2007. All remaining errors or omissions are solely my responsibility. A word of recognition is also due to Jochen Mierau, Richard Jong-A-Pin and Jakob de Haan for making their data set on political variables available, and to Reinhard Neck for superbly organizing the two mentioned sessions. The author also acknowledges financial support provided by the Portuguese Foundation for Science and Technology (FCT) under research grant POCI/EGE/60069/2004 (partially funded by FEDER, programme POCI 2010).
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Marinheiro, C.F. The stability and growth pact, fiscal policy institutions and stabilization in Europe. Int Econ Econ Policy 5, 189–207 (2008). https://doi.org/10.1007/s10368-008-0110-3
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DOI: https://doi.org/10.1007/s10368-008-0110-3