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.
Livio: I took a quick skim/read of the paper. Interesting. But the one area it seemed to miss was monetary policy. The standard argument for fiscal policy is that it affects aggregate demand. But monetary policy affects aggregate demand too. If the central bank is sensible, it will try to offset the effect of changes in fiscal policy on aggregate demand. So the only thing we will observe will be the central bank's mistakes: the sign of fiscal policy will be positive/negative if the central bank underestimates/overestimates the effect of fiscal policy on AD.
But if the country is part of the Eurozone, or has a fixed exchange rate, we won't get that monetary offset.
Posted by: Nick Rowe | June 09, 2014 at 05:01 PM
Looks like dodgy methodology to me. The results are inherently suspicious: they claim, if you look at the conclusions, that you can have general wage reductions with no reductions in household spending. Seems like cherry-picking of the time scale to me; this can happen in the short run, but is impossible in the several-year run.
The country cherry-picking is, as you noted, also suspicious, since these countries were in a really unusual situation, with a hell of a lot of other things going on.
This paper is very careful to pick its questions in order to get the (ideologically predetermined) conclusions it wanted.
To be fair to them, they admit that their methodology is dodgy and depends on insufficiently many data points to conclude anything.
Posted by: Nathanael | June 29, 2014 at 03:26 PM