Abstract
Following the financial crisis of 2007 and the sovereign debt crisis in 2010 that affected the soundness and reduced the strength of public finance in European countries, there has been a growing interest in developing methodologies to the help assess and signal the vulnerability of fiscal policy. Therefore, the aim of this study is to develop a new framework (V-L-D) to assess fiscal vulnerability. V-L-D represents a new methodology on the measurement of fiscal vulnerability that relies on the assumption that vulnerability can occur even during calm times. In comparison with previous methodologies that studied fiscal vulnerability around crisis and fiscal distress times, our framework investigates fiscal vulnerability near fiscal adjustments episodes. Our methodology relies on two distinct indicators: one showing the vulnerabilities indicated by the level of the cyclically adjusted budget balance and distance-to-stability, and one showing the vulnerabilities pointed out through the changes of the cyclically adjusted budget balance and public debt. V-L-D is able to classify fiscal vulnerability into five distinct categories having scores from 0 (no fiscal vulnerability) to 4 (extreme fiscal vulnerability). Using annual data ranging over 1990–2013 for 28 European Union countries, we evidenced 310 episodes of fiscal vulnerability, out of which 128 episodes of low vulnerability, 94 of moderate, 62 of strong, and 26 of extreme fiscal vulnerability. We also found that over 2004–2013, Greece, Portugal, Romania, United Kingdom, Ireland, Spain, and Slovenia were the most fiscally vulnerable countries in the Union. United Kingdom and Greece went through the longest episodes of fiscal vulnerability, counting 12 and 11 consecutive years, respectively. We tested our framework’s effectiveness against the Excessive Deficit Procedure. We found that the overall performance is good: V-L-D assessed moderate fiscal vulnerability during the procedure, strong fiscal vulnerability in the first year when procedure was initiated, and extreme vulnerability one year before the initiation.
Highlights
In recent decades, countries worldwide have faced various and growing challenges
Examining the total value of fiscal vulnerability over time, we can observe that in the years following the financial crisis in 2007, the European Union (EU) had to tackle the largest magnitude of fiscal vulnerability
If we study the magnitude of fiscal vulnerability in relation with the main regulations introduced by the European Commission, which were designed to maintain the soundness and strength of
Summary
Countries worldwide have faced various and growing challenges. Since the Great Depression in 1929–1933, the role of the government in the economy has been strongly revisited. Increasing peoples’ needs for education, healthcare, social security, and protection against poverty and inequality, and the call for better access to these goods, led to a more prominent role of governments in their provision. The European countries were the first to deliver public pension schemes and social protection through the public system [1]. One significant effect of these developments was the substantial increase in the social public spending, which caused government expenditures to grow. Roubini [3], and Alesina [4] warned on the negative effects of rising public social expenditures on fiscal sustainability, even if the generally accepted view on the welfare states is that they are characterized by sizeable budgetary deficits and public debts; Tanzi and Schuknecht [5]
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