Economic Fluctuations and Fiscal Policy in Europe: A Political Business Cycles Approach Using Panel Data and Clustering (1996–2013)

Abstract

The European Monetary Union (EMU) is the only Union that allows its members to conduct their own fiscal policy, which has to be consistent with the Maastricht treaty. This paper attempts to shed light on business cycles determinants focusing on fiscal variables in EU economies, in the time period 1996–2013, using quarterly data fully capturing the on-going recession. In this context, it also acknowledges the significant role of the Quality of Institutions and of the Elections in a Political Business cycles framework. Additionally, based on the business cycles characteristics of the EU economies it explores the potential formation of clusters in the EU economy. To this end, a number of relevant econometric techniques are employed such as: HP filtering, LLC tests; Ljung-Box tests; Fourier analysis; Rolling windows; Dynamic Panel Data analysis; Toda-Yamamoto causality test, Panel Seemingly Unrelated Regressions (SUR) and k-means clustering. Our findings suggest that Social Benefits, Social Transfers and Gross Debt are the most significant policy variables with a counter-cyclical character, while taxation was found to have a destabilizing effect. In addition, Elections and the Quality of Institutions were found to significantly affect the key fiscal variables examined. Meanwhile, most peripheral countries lie in one cluster suggesting that the recent crisis has led a number of small(-er) peripheral economies to cluster together.