ABSTRACT
The Maastricht Treaty and the Stability and Growth Pact (SGP) stipulate that budget balances in EU countries should be balanced over the business cycle, since this would allow automatic stabilizers to work properly in cushioning cyclical fluctuations and create some room for discretionary policy. Hence, in order to act in accordance with the intention of the SGP, governments should avoid pro-cyclical policies in recessions and strive for budgetary consolidation during economic booms; in other words, governments should behave counter-cyclically and react symmetrically to output fluctuations. This ‘ideal’ notwithstanding, there is evidence that fiscal policy behaved more pro-cyclically than counter-cyclically in the past decades. Thus the question arises to what extent a fiscal policy regime change is or would have been necessary in order for governments to comply with the spirit of the European fiscal rules. In order to analyse this issue for a country – as we do for Austria in this chapter – one
has to assess whether discretionary fiscal policy has actually offset or reinforced the operation of automatic fiscal stabilizers, whether there have been significant transitory variations in the fiscal position unrelated to business cycle fluctuations, and what the behaviour of the underlying (‘core’) fiscal position over time has been. The variability of the latter reflects discretionary measures not related to the cycle, such as permanent consolidation measures, measures aiming at distributional and allocative/structural goals or effects of macroeconomic shocks, demographic changes, etc. Correcting budget balances for the effects of the business cycle in general gives a better
measure of the policy-related part of the budget and reduces the simultaneity bias that may arise as budgets and economic growth interact. The conventional approach relies on adjusting the budget balance for the impact of the automatic stabilizers, i.e. decomposing the budget balance into two components: the cyclically adjusted balance and the automatic stabilizer component (or cyclical component). Adjusting the budget balance for the impact of the automatic stabilizers is only appropriate, for example, for predicting the room for discretionary stabilization policy measures in an economic slowdown, given a threshold for the general government deficit (since in this case the cyclical component should indeed be limited to effects of the automatic stabilizers). If, however, the aim is to analyse the policy behaviour related to macroeconomic developments, the adjustment should also include discretionary fiscal measures that have been a normal feature of a country’s stabilization policy (Boije 2004). On closer inspection, however, the cyclically adjusted budget balance contains several com-
ponents that capture different dimensions of fiscal policy, such as a core balance describing
the underlying fiscal position; a component reflecting discretionary fiscal policy responses to the business cycle that can move either pro-or counter-cyclically with the output gap; and a residual component capturing all remaining shocks to the fiscal position, reflecting transitory changes in the fiscal position due to non-stabilization-oriented discretionary policy and/or macroeconomic shocks.2 Disregarding these latter aspects could provide an explanation for the sometimes quite substantial variations of cyclically adjusted balances during the cycle. Following an approach suggested by Jaeger (1998) and expanded by Brandner and
Diebalek (2000), we track fiscal policy behaviour over time by decomposing the observed budget balance (as a percentage of GDP) into four unobserved components: (i) a core balance, (ii) an automatic or built-in fiscal stabilizer component, (iii) a component reflecting discretionary fiscal policy responses to the business cycle, and (iv) a component reflecting all other transitory shocks to the fiscal position. By means of an unobserved components (UC) model, we provide an estimate of a core
balance for Austria. For this purpose we analyse the relationship between the budget balance and the cyclical development of the Austrian economy by looking at the impact of both automatic stabilizers and discretionary policies aimed at output stabilization – with particular attention to the latter.3 By doing this, we can assess whether fiscal policy in a broader sense was pro-or counter-cyclical or reacted asymmetrically in up-or downturns. Moreover, by looking at disaggregated data, we can answer the question whether the procyclicality/counter-cyclicality was related primarily to the expenditure or the revenue side. In Section 4.2 we discuss some related literature before we move on to explain the
methodology chosen in Section 4.3. Section 4.4 is devoted to the discussion of the main results of our study; in Section 4.5 we draw some conclusions.
