Heterogeneity of fiscal adjustments in EU economies in the pre- and post-crisis periods: common correlated effects approach

Abstract

This paper empirically assesses the heterogeneity of spending-side fiscal adjustments in the European Union (EU) economies when questions related to sustainability and fiscal policy prudence were renewed during the global crisis. The research analyzes the fiscal adjustment differences between pre- and post-crisis periods using fiscal variables stock-flow system of 28 EU economies for the period 2000q1–2018q4. The study considers cross-sectional dependent, non-stationary, heterogeneous panels using multicointegration relation. Results of the Common Correlated Effects approach reveal weak fiscal sustainability and heterogeneous evidence of public expenditure fiscal adjustments to accumulated public debts in a stochastic environment. Allowing fiscal authorities to implement heterogeneous fiscal adjustments led to ad hoc public expenditure changes in certain economies. These public expenditure changes are distinguished from proposed fiscal adjustments to stabilize public debt. Empirical findings indicate that post-crisis complementarity between supranational and domestic fiscal arrangements needs to be continuously improved.