Well, here is a new contribution to the debate over the effect of fiscal policy shocks from the journal of the Institute for Fiscal Studies. The authors Paweł Borys, Piotr Ciżkowicz and Andrzej Rzońca are from the Warsaw School of Economics and look at the impact of fiscal policy shocks on EU new member states. Their results will be seen as contribution to the debate over austerity measures and whether one should stimulate economic activity through tax reductions or direct expenditure measures.
According to their abstract:
We identify fiscal policy shocks in the EU new member states using four different methods. We use panel data techniques to estimate the output response to these shocks. We find that investment and export growth increase after fiscal consolidation and decelerate after fiscal stimulus when the shocks are expenditure-based. In contrast, private consumption does not respond to fiscal policy shocks. Expenditure-based fiscal consolidations reduce wages, supporting the view that fiscal consolidation of such composition enhances the competitiveness and profitability of domestic enterprises. In contrast, we do not find evidence of fiscal shocks affecting households’ confidence.
The study uses data for EU new member states over the period 1995 to 2011 and finds that fiscal consolidation tends to be followed by faster output growth.Their policy points:
1. The composition of fiscal policy actions is relevant for their macroeconomic effects. Fiscal stimulus is effective in boosting GDP growth when it is tax-based, but not when it is mainly expenditure-based. In turn, expenditure-based fiscal consolidation does not appear to be costly in terms of GDP growth, but tax hikes reduce GDP growth.
2. Reduction in government expenditure is often accompanied by acceleration in exports and private investment growth. Expenditure-based consolidations contribute to improvements in countries’ short-term cost competitiveness by limiting wage pressure.
3. Discretionary changes in public deficit do not affect households’ expectations and consumption.
I guess I am not so sure I would have limited such a study to just the EU new member states even if as the authors state they are “understudied”. I also think a longer time span that incorporated other EU members would have been more useful in applying the results to policy discussion. The authors maintain that fiscal consolidation is more likely to be expansionary when public debt is high and growing as fiscal consolidation dispels the household fears of being burdened with future debt repayments and tax burdens. The EU new member states have had high levels of uncertainty regarding the sustainability of their public finances, which the authors suggest makes them a unique case.
The EU new member states used in this study are: Bulgaria, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia. I would argue that they are indeed a special case given that they are former Eastern Bloc economies that underwent a major institutional transformation during the 1990s. I suppose that explains the time period of the study also as their market transformation began after 1990. Even if one wants to stick to the 1995 to 2011 period, there are also other relatively new EU member countries such as Austria (1995), Cyprus (2004), Finland (1995), Malta (2004), and Sweden (1995) that were not included. Use of a broader set of countries – all of the EU for example - could have lead to results that could be more broadly applied. Still an interesting read.