ABSTRACT
This chapter investigates the sustainability of fiscal policy in several EC countries. We show that the government’s intertemporal budget constraint can only be satisfied if government receipts and outlays, as a percentage of GDP, are co-integrated. We then analyse the long-run relationship between these two series in each country. In most cases (Germany possibly being the only exception) government expenditure and revenue drifted apart. However, Kalman filter estimation reveals that the structure of fiscal policy has changed in the 1980s in many countries (Belgium, Denmark, Ireland, Italy, Netherlands and the UK), making it more sustainable. There is also evidence (Belgium, France, Germany, Italy, Netherlands, Spain, UK) of feedback mechanisms with stabilizing effects. Another finding is that tax smoothing does not occur, as revenue does not fully adjust to permanent shocks. Corrective fiscal action is still required in most countries to achieve sustainable debt positions and meet the rather stringent convergence criteria laid down in the Maastricht Treaty.
