Fiscal policy and the cycle in the Euro Area: The role of government revenue and expenditure

This paper analyses the cyclical behaviour of fiscal policy in euro-area countries over the 1980-2005 period, focusing on the distinct role of government revenue and expenditure. The estimation of separate fiscal policy reaction functions in good and bad times reveals that, controlling for other factors, the average stance of fiscal policy is expansionary when output is above potential, thus denoting a pro-cyclical bias in good times, while no strong evidence of a cyclical bias is found in bad times. The separate estimation of reaction functions for revenue and expenditure policy indicates that this pro-cyclical bias is an entirely expenditure-driven phenomenon. Probit regressions also reveal that the risk of pro-cyclicality in good times stems from expenditure behaviour, since expenditure-based budgetary adjustment is a highly significant determinant of the probability of pro-cyclical fiscal policy in good times. The separate estimation of fiscal reaction functions in EU countries with strong and weak expenditure rules provide some support to the view that expenditure rules can be helpful to curb the expansionary bias of expenditure policy in good times.Fiscal stabilisation, government revenue, government expenditure, fiscal rules, Turrini

Received wisdom and beyond: Lessons from fiscal consolidation in the EU

The paper examines consolidation episodes in the EU since 1970 with a view to shedding light on the factors that determine the success or failure of fiscal adjustment. Compared to the existing literature on successful fiscal consolidations we add a number of new dimensions. Two deserve particular attention. Firstly, we explore a broader set of potential ingredients of the recipe for success. In addition to the composition of adjustment, which has extensively been examined in the literature, we consider further elements such as the quality and strength of fiscal governance and the implementation of structural reforms. Secondly, our analysis seeks to differentiate between at least two different types of consolidation episodes, one in which a relatively big fiscal correction is implemented in a short period of time, dubbed 'cold shower' consolidation, as compared to more gradual episodes of adjustment. Such a differentiation is motivated by the conjecture that the recipe for success may be conditional on the type of adjustment chosen. Our analysis broadly confirms the results established in the literature for what concerns (i) the conditions triggering a consolidation episode and (ii) the composition of adjustment, with minor but important qualifications related to the role played by government wages. In addition it provides evidence that well-designed fiscal governance as well as structural reforms improve the odds of both starting a consolidation episode and achieving a lasting fiscal correctionFiscal consolidation, fiscal rules, budgetary procedures, structural reforms, Larch, Turrini

Public investment and the EU fiscal framework

It is often claimed that the introduction of the EU rules-based fiscal framework of the Maastricht Treaty and the Stability and Growth Pact was responsible for a decline in public investment shares in EU countries. Proposals have also been made in recent times in favour of a revision of the EU fiscal framework in such a way to grant special treatment to public capital expenditures (e.g., by amending it with a ‘golden rule'). This paper analyses empirically the relation between the introduction of the EU fiscal framework and public investment. Results from panel data analysis suggest that the impact of the EU rules for fiscal discipline is not a clear-cut one. On the one hand, after phase II of EMU, public investment is found to be more negatively affected by debt levels. This is consistent with the view that in the run-up to Maastricht the budgetary adjustment implied a significant decline in public investment, especially in high-debt countries. On the other hand, results indicate that after phase II of EMU public investment became positively related to previous period budget balances, so that the improvement in the budget balances consequent to the introduction of the EU fiscal rules may have helped to create room for public investment in several EU countries.public investment, EU fiscal framework, economic and monetary union, EMU, stability and growth pact, SGP, Maastricht Treaty, Public Private Partnerships, PPP, Turrini

Received wisdom and beyond: Lessons from fiscal consolidations in the EU

The paper examines consolidation episodes in the EU since 1970 with a view to shedding light on the factors that determine the success or failure of fiscal adjustment. Compared to the existing literature on successful fiscal consolidations we add a number of new dimensions. Three deserve particular attention. Firstly, we explore a broader set of potential ingredients of the recipe for success. In addition to the composition of adjustment, which has extensively been examined in the literature, we consider further elements such as the quality and strength of fiscal governance and the implementation of structural reforms. Secondly, our analysis seeks to differentiate between at least two different types of consolidation episodes, one in which a relatively big fiscal correction is implemented in a short period of time, dubbed 'cold shower' consolidation, as compared to more gradual episodes of adjustment. Thirdly, we check whether the 'recipe for success' changed over time. Our analysis broadly confirms the results established in the literature for what concerns (i) the conditions triggering a consolidation episode and (ii) the composition of adjustment, with minor but important qualifications related to the role played by government wages. In addition it provides evidence that well-designed fiscal governance as well as structural reforms improve the odds of both starting a consolidation episode and achieving a lasting fiscal correction. Our analysis also shows that the composition of successful and unsuccessful consolidation has become more similar over time and that other discriminating factors such as fiscal governance and structural reforms turn out to make an increasing difference for success.Fiscal consolidations, fiscal rules, budgetary procedures, structural reforms

Fiscal Consolidation in Reformed and Unreformed Labour Markets: A Look at EU Countries

This paper estimates the impact of fiscal consolidation on unemployment and job market flows across EU countries using a recent database of consolidation episodes built on the basis of a narrative approach (Devries et al., 2011). Results show that the impact of fiscal consolidation on cyclical unemployment is temporary and significant mostly for expenditure measures. As expected, the impact of fiscal policy shocks on job separation rates is much stronger in low-EPL countries, while high-EPL countries suffer from a stronger reduction in the rate at which new jobs are created. Since a reduced job-finding rate corresponds to a longer average duration of unemployment spells, fiscal policy shocks also tend to have a stronger impact on long-term unemployment if EPL is stricter. Results are broadly confirmed when using top-down fiscal consolidation measures based on adjusting budgetary data for the cycle

Traders, Courts and the Home Bias Puzzle

Recent evidence shows that the “home bias puzzle” in international trade may be associated with the mere presence of national borders (McCallum (1996)). In this paper we provide a theoretical framework to explain why borders may matter so much for trade. Our argument is that even between perfectly integrated and similar countries the legal system differs, so that legal costs are higher when business is done abroad. Using a matchig model of trade, we show that the home bias is associated with both less searching foreign sellers in the home market and a lower probability of cross-border matches being accepted. In industries characterized by high turnover legal costs may reduce trade because reducing the mass of searching foreign sellers and increasing at the same time that of searching domestic sellers.Cross-border trade, legal costs, matching

Europe’s austerity policies may have created less unemployment in countries with liberalised labour markets.

Austerity policies have been linked to rising unemployment in European countries, but what effect have policies aimed at liberalising labour markets had during the crisis? Alessandro Turrini finds that contrary to expectations, austerity policies may have been responsible for creating more unemployment in countries with stronger employment protection legislation. One potential reason for this is that while countries with more regulated labour markets have not experienced as many redundancies from austerity, they have also had far lower job creation levels

Fiscal consolidation and unemployment: does EPL matter? A look at EU countries

This paper estimates the impact of fiscal consolidation on unemployment and job market flows across EU countries using a recent database of consolidation episodes built on the basis of a 'narrative' approach (Devries et al., 2011). Results show that the impact of fiscal consolidation on cyclical unemployment is temporary and significant mostly for expenditure measures. As expected, the impact of fiscal policy shocks on job separation rates is much stronger in low-EPL countries, while for high-EPL countries there is a stronger reduction in the rate at which new jobs are created. Since a reduced job-finding rate corresponds to a longer average duration of unemployment spells, fiscal policy shocks also tend to have a stronger impact on long-term unemployment if EPL for permanent contracts is stricter

The Cyclically Adjusted Budget Balance in EU Fiscal Policymaking. Love at First Sight Turned into a Mature Relationship

The cyclically adjusted budget balance (CAB) plays a key role in the EU fi scal surveillance framework. It started off in a supporting role in the shadow of the headline defi cit and, before long, turned into the linchpin of the rules of the Stability and Growth Pact. The steep ascent was driven by high expectations which, with the passing of time, were only partly met. The everyday practice of the EU fi scal surveillance rapidly revealed a number of caveats of the CAB which, at times, hampered the effectiveness of fi scal surveillance. This paper provides a comprehensive review of the changing fortunes of the CAB in the EU fi scal surveillance framework. It portrays its main shortcomings and the way they are dealt with in practice.Cyclically adjusted budget balance, Stability and Growth Pact, Fiscal Policy

Trade, Wages and ´Superstars’

We study the effect “globalization” on wage inequality. Our “global” economy resembles Rosen (1981) “Superstars” economy, where a) innovations in production and communication technologies enable suppliers to reach a larger mass of consumers and to improve the (perceived) quality of their products and b) trade barriers fall. When transport cost fall, income is redistributed away from the non-exporting to the exporting sector of the economy. As the latter turns out to employ workers of higher skill and pay, the effect is to raise wage inequality. Whether the least skilled are stand to lose or gain from improved production or communication technologies, in contrast, depends on whether technology is skill-complement or substitute. The model provides an intuitive explanation for why changes in wage premia are so strongly affected by export’ growth in plant-level empirical investigations (Bernard and Jensen (1997)).International trade, wage inequality, technological change