Download R. Beetsma

On the Relationship between Fiscal
Plans in the European Union:
An Empirical Analysis Based
on Real-Time Data
Massimo Giuliodori & Roel Beetsma
(University of Amsterdam)
Overview
1. Motivation and related literature
2. Data Description
3. Model Specification
4. Empirical Results
•
•
•
•
Baseline Specification
Robustness
Estimates based on unadjusted primary deficit
Small versus large countries
5. Conclusion
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1. Motivation
• Spillover Effects of Fiscal Policy in the Europe
• They can work indirectly through the economy
1. Economic/indirect spillover of fiscal expansion
• Debt-financed  long-term interest rate goes up (-)
e.g. Ardagna et al (2005) and Faini (2006)
• Inflation goes up  ECB raises euro-zone short-run interest
rate (-)
• Output increases  foreign exports to domestic country
increase (+)
e.g. Giuliodori and Beetsma (2004) and Beetsma, Giuliodori,
Klaassen (2006)
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1. Motivation (cont’d)
•
Spillovers can also work directly:
2. “Pure” or “direct” policy spillovers
•
•
•
Expenditure side  investment expenditure to attract
business from abroad or voters comparing quality and
quantity of domestic infrastructures (+)
e.g. Case, Rosen and Hines (1993) and Redoano (2003)
Revenue side  competition for mobile tax base (+)
e.g. Besley and Case (1995), Devereux et al., (2002) and
Baicker (2005)
Decision process side  meetings of ECOFIN (implicit or
tacit interdependence) or ‘peer pressure’ within the current
fiscal regime (+)
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1. Motivation (cont’d)
• This paper: empirical analysis of the presence of
‘pure’ policy or ‘direct’ spillovers.
– Have received much less attention than indirect
spillovers via the economy
– Better information on spill-over effects promote better
alignment of national fiscal policies
– How can peer pressure be made to work most
efficiently? How can countries be motivated to put
pressure on each other to improve quality of public
finances and conduct fiscal reforms?
• Wider implications
– How can countries be motivated to positively affect
each other even when there are no tangible sanctions
(e.g. Lisbon goals)?
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1. Motivation (cont’d)
• Two main contributions
– Study of the determinants of fiscal plans using real-time
information at the time the budget is planned
– Extension of ‘traditional determinants’ with external
fiscal policy conditions
• Advantage of using plans
– More informative about fiscal behavior: realized fiscal
policy is sum of plan plus (often ad hoc) response to
unforeseen developments
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2. Data Description
• Modeling fiscal plans implies the use of data and information
available at the time of decision
• For monetary rules (Orphanides, 1997, 2001, 2003 etc) this implies
conditioning the operating instrument on real-time information
e.g.
it  h  te   *  , gapte 
• This applies also to fiscal rules, with the difference that also the
objective is subject to revisions (Cimadomo, 2006)
e.g.
ft e  h  gapte , ft e* , ft e1 
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2. Data Description
• We construct a new real-time dataset for the period 1995-2006
for 14 EU countries using the OECD Economic Outlook (EO)
• The EO is published twice a year (June and December)
• Given that the timing of the fiscal policy process is generally
concentrated in the Autumn of each year, we take the real-time
information based on the December issue
• All data from same issue  maximum of consistency
• For each year t (vintage t), we take the current estimates of fiscal
and business cycle stances for year t (E) and the planned or
forecast (F) business cycle stances for year t+1
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2. Data Description
• For each country i we collect:
CAPDFit
=
cyclically adjusted primary deficit over
GDP for year t forecast in December of year t-1
CAPDEi,t-1 =
cyclically adjusted primary deficit over GDP
for year t-1 estimated in December of year t-1
YGFit
output gap for year t forecast in December of
year t-1
=
DEBTEi,t-1 =
Gross Government Debt over GDP at the end of
year t-1 estimated in December of year t-1
…and other ‘standard’ real-time control variables
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3. Model Specification
• Baseline specification:
CAPDFit = ci + CAPDEi,t-1 +  CAPDFWYit + ’ xit + uit
CAPDFWYit =
forecast
GDP-weighted average cyclically adjusted
primary deficit over GDP for year t
in December of year t-1
Idea: if partners relax fiscal stance, country i perceives more
(political) freedom to do so too
xit
=
vector of other control variables including:
YGFit , DEBTEi,t-1 ,
YGFOECDt = forecast of the OECD output gap
NONACTIVEit = share of young plus old in the population
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ELECTit
= dummy for election year
3. Model Specification (cont’d)
• Additionally, following Forni and Momigliano (2004), to control
for the external constraints given by the Maastricht criteria and
SGP we construct:
Mi,t-1
SGPi,t-1
= (DEi,t-1-3%)/(1997- t), if DEi,t-1 >3%, t<1997
(Greece t<1999) and i is currently in the Euro-area
= 0, otherwise
= (DEi,t-1-3%)/2, if DEi,t-1 >3%, t 1997
(Greece t1999) and i is currently in the Euro-area
= 0, otherwise
where Dei,t-1 is the total deficit over GDP of country i for year t-1
estimated in December of year t-1
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4. Empirical Results – baseline
• Both OLS and IV estimation, with country fixed effects
• Instruments for YGFit => YGEi,t-1 and YGEOECDt-1
• Instruments for CAPDFWYi,t => CAPDEWYi,t-1 and
YGEWYi,t-1
• Given that CAPDFWYi,t may be not in the information set,
we also look at cases where we substitute it with:
CAPDFJWYi,t =
GDP-weighted average cyclically
adjusted primary deficit over GDP for
year t forecast in June of year t-1
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Table 2: Estimates of baseline fiscal rules
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4. Empirical Results: robustness
• Given that CAPDFWYi,t may be not in the
information set, we also look at cases where we
substitute it with:
CAPDFJWYi,t = GDP-weighted average cyclically
adjusted primary deficit over
GDP for year t forecast in June
of year t-1
• Alternative weighting scheme: geographical
distance between capitals => CAPDFWDit and
CAPDFJWDit
• Normalizing CAPDFi,t , CAPDFWYi,t CAPDFJWYi,t
for potential output
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Table 3: June forecasts and weighting scheme based on distance
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Table 4: Normalizing by potential output
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4. Empirical Results: robustness
• Alternative and additional controls
– Improve specification
– Check for alternative common driving factors
– Capture indirect fiscal spillovers
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Table 5: Additional controls – improved specification
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Table 6: Alternative common driving factors
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Table 7: Controls to capture indirect fiscal spillovers
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4. Empirical Results: robustness
• Have we inadvertently excluded time
dummies?
– Replace CAPDFWYit with time dummies
– Strong positive correlation time effects and
fiscal interaction term
– When jointly included time effects and fiscal
interaction term are both insignificant
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Figure 2: Time effects versus “external” fiscal factors
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4. Empirical Results: robustness
• EU versus non-EU countries – idea:
– Check for possibility of some common world
factor driving all OECD fiscal stances
– If existent, group of non-EU countries should
show similar results as EU-group
– Also EU average stance should drive non-EU
countries stances and vice versa
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Table 8: Split into groups of non-EU and EU countries
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Table 9: Fiscal behaviour before and after SGP
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4. Empirical Results: non-adjusted
primary deficits
• Cyclical adjustment may potentially affect
results
• Control for absence of cyclical adjustment
by including output gap as regressor
• Common versus country-specific response
• Include average of foreign average
cyclically adjusted primary deficit –
conceptually the correct regressor
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Table 10: Non-adjusted primary deficits
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4. Empirical Results: small versus
large countries
• Consensus view: large countries behave
differently
• Large countries are responsible for most
violations of the SGP
• Do large countries react differently to
average fiscal stance?
• Do the groups affect each other?
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Table 11: Split into large and small countries
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Table 12: Do groups affect each other?
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5. Conclusions
• The paper explores the potential importance of pure
cross-border fiscal policy spill-overs in the EU
• Dataset based on real-time information to model the
actual fiscal plans of policy makers
• Our empirical results indicate that such spill-overs
potentially exist and these results are robust to several
variations
• Key question is what is the source of these spill-overs?
–
–
–
–
Preventive arm of SGP
Tax competition?
Expenditure/investment competition?
Answer is important to judge to what extent countries will
press each other to achieve Lisbon goals
– We would need forecasts of deficit components
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5. Conclusions (cont’d)
• Split of sample into small and large countries
suggests that only the small countries, and not
large countries, react to average EU movements in
the deficit
• Common over-optimism biases unlikely
(otherwise small and large would react similarly)
• Also large countries do not react to each other 
‘peer pressure’ does not seem to work for large
countries
• Results may help us to infer to what extent
countries might press each other to improve
quality of finances, conduct fiscal reform and take
measures to achieve Lisbon goals
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