FISCAL POLICY IN EUROPE: THE CREDIBILITY IMPLICATIONS OF REAL WAGE RIGIDITY *

Abstract

MANY economists would agree that in the last 10 or 15 years most European governments have seemed unwilling to follow the Keynesian idea of using fiscal policy as a counter-cyclical device, i.e. for stabilizing output or employment around some desired level. Indeed, they seem to have been much more keen to achieve 'financial soundness' in their budgeting, with stability of monetary aggregates and the control of inflation in mind. The most extreme examples of this are Germany, and the UK under Mrs. Thatcher. Conversely, much of the American (and world) recovery in the years following the 1981-82 depression could be largely attributed to the unprecedented expansionary fiscal policy of the Reagan administration. Some evidence supporting the view that fiscal policy has played a more active role in stabilizing output in America than in Europe is presented in Figures 1 to 4. The figures plot the 'structural budget surplus' and the 'output gap', both as a percentage of GDP peak, for the main seven industrialized countries, as measured by the OECD. A positive gap indicates that the economy is working below capacity. A positive 'structural' balance indicates a cyclically-adjusted surplus (net government lending). The contrast between North America and Europe is striking: in the US, and even more in Canada, the two curves move symmetrically, indicating a persistent tendency for a looser stance of fiscal policy in recessions and tightening in recovery. In the US this pattern weakens after 1984. Conversely, in the UK and in Germany since 1977, the two curves run almost parallel, indicating, if anything, a pro-cyclical tendency. The French case is mixed; there appears to be a switch in policy regime in the early 1980s, towards a policy aimed at reducing imbalances independently of the business cycle. With the exception of the two major recessions, the Italian stance of fiscal policy seems hardly dominated by stabilization purposes, while Japan's case falls between the extremes of Europe and North America. Table 1 shows the simple correlation coefficient (rho) between the adjusted surplus and the output gap, both as a percentage of the GDP peak. The more