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Macroeconomic effects of fiscal policy in the European Union, with particular reference to transition countries
Rilind Kabashi* 
Rilind Kabashi
Affiliation: Monetary Policy and Research Department, National Bank of the Republic of Macedonia, Skopje, Republic of Macedonia
 0000-0001-7597-6495
Correspondence
kabashir@nbrm.mk
Article | Year: 2017 | Pages: 39 - 69 | Volume: 41 | Issue: 1 Received: October 19, 2016 | Accepted: December 1, 2016 | Published online: March 10, 2017
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FULL ARTICLE
FIGURES & DATA
REFERENCES
CROSSMARK POLICY
METRICS
LICENCING
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Note: The size of the spending shock in the entire sample and in all sub-samples discussed below equals 1% of GDP, which is equivalent to around 4% of government spending in the entire sample.
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Forecast
error variance decomposition of GDP
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At
impact
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After 1 year
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After
3 years
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After
5 years
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Contributions
of shocks to:
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Real gov. spending
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8.4
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7.8
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5.7
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4.7
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Real cycl.-adj. net-taxes
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4.6
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10.8
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20.6
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25.7
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Real GDP
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87.0
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78.9
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66.1
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59.9
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GDP deflator
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0.0
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0.7
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1.9
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2.1
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Nom. Short-term rates
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0.0
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1.7
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5.7
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7.6
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100.0
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100.0
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100.0
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100.0
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Contributions
of the gov. spending chock
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At impact
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After 1 year
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After 3 years
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After 5 years
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To
the FEVD of:
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Real gov. spending
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100.0
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94.5
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72.7
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58.6
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Real cycl.-adj. net-taxes
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1.5
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0.9
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1.9
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2.8
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Real GDP
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8.4
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7.8
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5.7
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4.7
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GDP deflator
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0.8
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1.9
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3.1
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3.1
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Nom. Short-term rates
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0.5
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0.4
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1.0
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1.1
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Size
of the fiscal multiplier
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On
impact
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After
one year
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After
3 years
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After
5 years
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Baseline
(EU27, 1995-2012)
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1.0***
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1.1***
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0.4*
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-0.1
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Old
EU member states (EU17)
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0.6***
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1.0***
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0.6**
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-0.2
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New
EU member states (NMS10)
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1.3***
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1.4***
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1.0**
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0.9
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High debt (debt/GDP>60%)
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0.6***
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1.1***
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0.3
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-0.8*
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Low
debt (debt/GDP<60%)
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1.0***
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1.1***
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0.5*
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0.3
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High
openness (>50% of GDP)
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1.1***
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0.9***
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-0.2
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-0.6
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Low
openness (<50% of GDP)
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0.7***
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1.2***
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0.7**
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0.1
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Pre-crisis
(EU27, 1995-2008)
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0.4***
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0.3**
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-0.1
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-0.4
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Note: The table shows the size of the fiscal multiplier, i.e. the response of real GDP (in %) to a government spending shock of 1% of real GDP. ***, ** and * denote significance at the 1%, 5% and 10% level, respectively.
Note: Only responses of the additional variable in each of the four 6-variable PVARs are shown. Complete results of each specification are available on request.
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Variable
name
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Variable
description (original titles for variables not calculated by formula)
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Source
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ca_gov_nt_real
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Real
cyclically-adjusted net-taxes
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Formula
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ca_gov_rev
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Cyclically-adjusted
government revenues
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Formula
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ca_gov_rev_real
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Real
cyclically-adjusted government revenues
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Formula
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ca_gov_tran
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Cyclically-adjusted
government transfers
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Formula
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ca_gov_tran_real
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Real
cyclically-adjusted government transfers
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Formula
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cit_dir
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Share of
corporate income tax in direct taxes
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Formula
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comp_avg
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Nominal
compensation per employee: total economy
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AMECO
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comp_avg_real
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Real wages
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Formula
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comp_gg
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Compensation
of employees: general government :- ESA 1995
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AMECO
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comp_gg_cons
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Real
government wage bill
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Formula
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debt
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General
government consolidated gross debt :- excessive deficit procedure (based on
ESA 1995) and former definition (linked series)
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AMECO
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debt/ngdp
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Debt/GDP
ratio
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Formula
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def_gc
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Price
deflator total final consumption expenditure of general government, 2005=100
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AMECO
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def_gdp
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GDP deflator
(price deflator gross domestic product at market prices, 2005=100)
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AMECO
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def_gfcf
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Price
deflator gross fixed capital formation: total economy, 2005=100
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AMECO
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el_cit
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Elasticity
of corporate income tax with respect to the output gap
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EC (2005)
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el_dir
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Elasticity
of direct taxes with respect to the output gap
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EC (2005)
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el_ind
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Elasticity
of indirect taxes with respect to the output gap
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EC (2005)
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el_pit
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Elasticity
of personal income tax with respect to the output gap
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EC (2005)
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el_prexp
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Elasticity
of current primary expenditures with respect to the output gap
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EC (2005)
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el_soc
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Elasticity
of social contributions with respect to the output gap
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EC (2005)
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empl
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Employment (employees,
persons: all domestic industries; national accounts)
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AMECO
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expend_curr
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Total
current expenditure: general government :- ESA 1995
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AMECO
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expend_curr_pr
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Current
primary expenditures
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Formula
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gc
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Final
consumption expenditure of general government at current prices
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AMECO
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gc_cons
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Real government
consumption
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Formula
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gc_nw_cons
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Real
government non-wage consumption
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Formula
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gdp_cons
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Real GDP (gross
domestic product at 2005 market prices)
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AMECO
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gdp_trend
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Trend gross
domestic product at 2005 market prices (based on the Hodrick-Prescott filter)
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AMECO
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gfcf_gg
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Gross fixed
capital formation at current prices: general government
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AMECO
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gfcf_gg_cons
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Real
government investment
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Formula
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gfcf_priv
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Gross fixed
capital formation at current prices: private sector
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AMECO
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gfcf_priv_cons
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Real private
investments
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Formula
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gov_spend_real
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Real
government spending
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Formula
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gov_tran
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Government
transfers
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Formula
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inter
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Interest :
general government :- ESA 1995
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AMECO
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ir_st
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Nominal
short-term interest rates
(note: the
series corresponds to nominal 3-month money market interest rates)
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AMECO and
IMF IFS
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m
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Imports of
goods and services at current prices (national accounts)
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AMECO
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ngdp
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Nominal GDP
(gross domestic product at current market prices)
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AMECO
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open
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Trade
openness
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Formula
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pc_cons
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Real private
consumption (private final consumption expenditure at 2005 prices)
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AMECO
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pit_dir
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Share of
personal income tax in direct taxes
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EC (2005)
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prop_paid
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Property
income, payable
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Eurostat
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prop_rec
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Property
income, receivable
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Eurostat
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rev_curr
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Total
current revenue: general government :- ESA 1995
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AMECO
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soc_ben_paid
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Social
benefits other than social transfers in kind: general government :- ESA 1995
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AMECO
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soc_rec
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Social
contributions received: general government :- ESA 1995
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AMECO
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subs
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Subsidies:
general government :- ESA 1995
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AMECO
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tax_dir
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Current
taxes on income and wealth (direct taxes): general government :- ESA 1995
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AMECO
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tax_ind
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Taxes linked
to imports and production (indirect taxes): general government :- ESA 1995
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AMECO
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trpg
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Other
current transfers paid by government
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Formula
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trrg
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Other
current transfers received by government
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Formula
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x
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Exports of
goods and services at current prices (national accounts)
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AMECO
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Equation 1The structural form of baseline panel VAR DISPLAY Equation
Figure 1Impulse responses to a government spending shock of 1% of real GDP – baseline specification DISPLAY Figure
Figure 2Comparison of impulse responses to a government spending shock of 1% of real GDP – old and new EU member states DISPLAY Figure
Table 1Forecast error variance decomposition – baseline specification DISPLAY Table
Figure 3Comparison of impulse responses to a government spending shock of 1% of real GDP – high-debt and low-debt countries DISPLAY Figure
Figure 4Comparison of impulse responses to a government spending shock of 1% of real GDP – more and less open countries DISPLAY Figure
Table 2Fiscal multipliers in the entire sample and in various sub-samples DISPLAY Table
Figure 5Comparison of impulse responses to a government spending shock of 1% of real GDP – baseline and pre-crisis period DISPLAY Figure
Figure 6Impulse responses of additional variables to a government spending shock of 1% of real GDP – extended PVARs with 6 variables DISPLAY Figure
Figure 7Impulse responses of GDP to a shock of 1% of real GDP in various spending components DISPLAY Figure
Figure 8Comparison of impulse responses to a government spending shock of 1% of real GDP – baseline and baseline extended with debt/GDP as endogenous variable DISPLAY Figure
Figure 9Comparison of impulse responses of GDP to a government spending shock of 1% of real GDP with and without debt/GDP – old and new EU member states DISPLAY Figure
Table A1Data sources and definitions DISPLAY Table
* The views expressed in this paper are those of the author and do not necessarily represent the views of the National Bank of the Republic of Macedonia. The author is grateful to Geoff Pugh of Staffordshire University for helpful comments and to Georgios Georgiadis of the European Central Bank for the Matlab code for Panel VAR and additional advice provided in our correspondence. Also, the author is grateful to two anonymous referees for their comments.
A previous version of this paper was presented at the conference Public Sector Economics organized by the Institute of Public Finance and Friedrich-Ebert-Stiftung in Zagreb on October 14-15, 2016.
1 A comprehensive review of the extensive theoretical and empirical literature is out of the scope of the current study. Therefore, we only briefly review the main contributions and then proceed with our empirical investigation. For reviews of the theoretical literature see Hebous (  2011) and Hemming et al. ( 2002). For meta-regressions of the empirical literature see Rusnak ( 2011) and Gechert and Will ( 2010).
2 For an extensive description of PVARs, important methodological issues and their treatment, see Juessen and Linnemann ( 2010) and Canova and Ciccarelli ( 2013).
3 Although Juessen and Linnemann ( 2010) recommend the use of bias-corrected PVAR FE, they also warn that bias-correction methods might not be successful in reducing the bias when the time dimension is small, which certainly covers our case of 18 years.
4 Cyprus and Malta joined EU in 2004 as well, but they are grouped with old EU member states because their economic structure and history makes them much closer to them than to the transition countries of Central and Eastern Europe which joined the EU at the same time or in 2007.
5 This also implies that, when discussing fiscal multipliers, effectively this applies to government spending multipliers.
6 We estimate our PVARs using the MATLAB code that has been developed and made public by Georgios Georgiadis, to whom we are grateful for the code and additional advice provided in our correspondence. The code is explained in Georgiadis ( 2012) and can be downloaded from here. It can also estimate Panel Conditional Homogenous VARs.
7 The one-for-one response means that a unit increase of government spending corresponds to a unit increase of GDP. If there are no stronger multiplicative effects, this is true by definition, since the definition of GDP also includes government spending (government consumption and investment).
8 The threshold of 60% is in line with the Maastricht criteria for public debt. However, results are similar if the threshold is defined as 50% instead.
9 Openness is calculated as the share of foreign trade in nominal GDP. Foreign trade is calculated as the sum of nominal exports and imports of goods and services divided by 2.
10 Most studies on US data use private sector wages and employment. While such an approach would be consistent with the use of private consumption and investment, data on private sector wages and employment for EU countries are not available from the European Commission AMECO database.
11 Each new variable is added before GDP. However, as discussed above, the ordering does not matter since we are interested only in the effects of spending shocks, which are ordered first.
12 When splitting the sample into old and new EU member states, we find similar dynamics and signs of the responses in the two groups, although there are some differences in the strength of the responses. In particular, the rise of consumption, wages and employment is stronger in new EU member states, and this holds both at impact and into the future. These results are available on request.
13 We also considered the effects of various government spending components on private consumption and investment separately by replacing GDP with private consumption and private investment, and then replacing government spending with its components one at a time. Overall, results indicate that fiscal policy works mostly via its effects on private investment, which normally appears to be more responsive, whereas responses of private consumption are lower, in line with the expected higher inertia in household consumption. These results are available on request.
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