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Fabrizio Balassone and Maura Francese (*)

Cyclical Asymmetry in Fiscal Policy, Debt Accumulation and the Treaty of Maastricht. Fabrizio Balassone and Maura Francese (*). (*) Banca d’Italia - Research Department. Structure of the presentation 1 - Motivation 2 - The stylised framework 3 - Empirical results

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Fabrizio Balassone and Maura Francese (*)

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  1. Cyclical Asymmetry in Fiscal Policy, Debt Accumulation and the Treaty of Maastricht Fabrizio Balassone and Maura Francese (*) (*) Banca d’Italia - Research Department

  2. Structure of the presentation • 1 - Motivation • 2 - The stylised framework • 3 - Empirical results • 3.1 - Asymmetry in fiscal policy • 3.2 - Impact of EMU fiscal rules • 3.3 - Debt accumulation • 4 - Conclusion and Possible extensions

  3. Motivation three issues on which evidence is scarce and not conclusive a - is fiscal policy asymmetric over the cycle? EC (2001), Buti et al. (1998), Buti-Sapir (1998), b - if so, how did this contribute to debt accumulation? Melitz (2002) c -did EMU fiscal rules affect fiscal reaction to the cycle? Galì-Perotti (2003)

  4. Stylised framework: (1) fiscal balance components 1) bt = blt + bct bt budget balance (with bt>0 indicating a deficit) blt long-run component bct cyclical component 2) blt = bt-1 +  ( b* - bt-1) +  (d* - dt-1) ,>0 dt government debt b*, d* preferred levels; d*=b*/k k trend nominal growth 3) bct = E[t] t output gap

  5. Stylised framework: (2) asymmetry in fiscal policy 4) bct = p E[tP] + n E[tN] pn E[t] if E[t] >0 E[tP] = 0 if E[t] <0 E[t] if E[t] <0 E[tN]= 0 if E[t] >0

  6. Stylised framework: (3) the estimating equation 5) bt= 0+1dt-1+ 2bt-1+p E[tP] + n E[tN] where 0=(+/k)b* 1=- 2=(1-) Stabilisation policy n,p<0 Index of asymmetry in the conduct of fiscal policy: 6)  = n - p

  7. The data sample: EU countries (excluding Luxembourg), USA and JP coverage for b and d ranges from 1969-2002 to 1977-2002 output gap: E[t] = t t: HP filter applied to GDP (1960-2004) drop from 2001 (end point bias)

  8. Empirical results: (1) Asymmetry in fiscal policy

  9. Empirical results: (2) Impact of EMU rules

  10. Empirical results: (3) Debt Accumulation (7) dt= dt-1/(1+kt) + b^t + st where b^t = OLS fitted values st = stock-flow adj.

  11. Debt Accumulation: a graphical illustration d t asymmetric d * a t d * s t no reaction symmetric t 1 2

  12. Conclusions and possible extensions Main findings: - significant cyclical asymmetry in fiscal policy (n=-0.4; p=0.0) - sizeable contribution to debt accumulation (about one third) - no effect from EMU fiscal rules Possible extensions: - separate analysis of revenue and expenditure - distinction between automatic and discretionary reaction - robustness to different measures of expected output gap - specification of control variables to account for different governments and institutional settings

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