Automatic Fiscal Stabilizers Research Articles

Asymmetries in post-war monetary arrangements in Europe: From Bretton Woods to the Euro Area

This paper provides a perspective on monetary cooperation in Europe, before and after the creation of the euro area (EA), focusing on macroeconomic and financial asymmetries among its member states. After surveying the evolution of EU macroeconomic and monetary arrangements and developments before and after the creation of the euro, and particularly the euro area crisis, we argue that economic and financial asymmetries have played a key role in post-war monetary arrangements in Europe. Such asymmetries have also characterized the euro area, which needs fundamental fiscal, financial and labor market reforms in order to operate more efficiently as an optimum currency area. Two key reforms would be a common EA budget of sufficient size, which would help smooth out the asymmetric impact of macroeconomic shocks through the operation of automatic fiscal stabilizers and the explicit recognition of the ECB as a lender of last resort in times of crisis.

This time truly is different: The cyclical behaviour of fiscal policy during the Covid-19 crisis

Fiscal policy was more countercyclical during the Covid-19 crisis than in previous (crisis) episodes. This paper presents empirical evidence in favour of a “this time truly is different” moment based on analysing the cyclical behaviour of fiscal policy for 28 advanced economies over 1995–2021. Discretionary fiscal policy during the Covid-19 crisis (2020–2021) did more to counteract the downturn – especially in the Eurozone –, as we do not find comparable evidence for countercyclicality during the financial crisis or Euro crisis. Automatic fiscal stabilisers, the non-discretionary domain of fiscal policy, significantly contributed to countercyclical stabilisation during the pandemic.

Milton Friedman and the Road to Monetarism: A Review Essay

Milton Friedman and the Road to Monetarism: A Review Essay

The role of automatic stabilizers in business cycle: the case of indonesia

TThe use of large fiscal stimulus packages to dampen the impact of Covid-19 recently has raised concerns about the effectiveness of the discretionary fiscal policy. This paper aims at analysing the feasibility of automatic fiscal stabilisers to mitigate economic fluctuations in the case of Indonesia. Using the IMF standard model for quarterly data over the period of 2001(1) to 2019(4), we find that the role of automatic fiscal stabilisers is getting greater both in revenue and spending. This implies that the automatic fiscal stabilisers are feasible as the main fiscal policy instrument for economic stability goals in the future. However, given the existing circumstances, Indonesia has to reform economic, regulatory, and institutional ecosystems in adopting the automatic fiscal stabilisers.

Макроэкономическая политика на перепутье

The article examines macroeconomic policy options for advanced economies to respond to adverse shocks in the environment of very low interest rates and very high levels of public debt, when the scope for using conventional policy tools is limited. The standard transmission mechanism of monetary policy in the ELB conditions stops working normally, and the economy faces the “liquidity trap” effect. The deployment by central banks of unconventional monetary tools (forward guidance, quantitative easing, and negative interest rates) after global financial crisis was helpful in combatting the downturn, but carries risk of possible side effects. Large-scale purchases of financial assets lead to significant increase in central banks’ balance sheets, and this creates a threat to future financial stability and central bank independence. Negative interest rates can have detrimental effects on bank profitability and be contractionary through bank lending. There is a consensus that today fiscal policy has to play a major role in stabilizing the business cycle. But the effectiveness of conventional tools of discretional fiscal policy is uncertain because of long political lags and small spending multiplier. Existing automatic fiscal stabilizers are focused on social protection goals and not on macroeconomic stabilization. Thus, the newly proposed measures for rules-based fiscal stimulus (asymmetric semiautomatic stabilizers – tax or spending measures triggered by the crossing of some statistical threshold, e.g. a high unemployment rate) and unconventional fiscal policy (the use of consumption taxes to increase inflation expectations) have become the object of active discussion. Here lies the danger in the fusion of monetary and fiscal policy: central banks’ operations are becoming increasingly quasi-fiscal, aimed at financing budget deficit, and functions of monetary policy are proposed to assign to fiscal policy. Besides, the expansion of fiscal stimulus threatens financial stability in the future, as it leads to increase in public debt and narrows a country’s fiscal space.

Solving policy problems, at the Federal Reserve and elsewhere

Addressing policy problems involves teamwork, leadership, and clear communications—examples range from addressing the 9/11 crisis to passing the Check-21 Act. The U.S. continues to face the major problems of financing retirement and health care. There are no magic answers—it is an interesting time to be an economist thinking about entitlements. Climate change is another area that economists are trained to think about, and it may be starting to play into conversations about central banking, adding to questions about the use of nontraditional tools. While there are proposals to increase the use of automatic fiscal stabilizers, these may look simple, but are quite complex in reality.

The Fiscal Policy of Bulgaria from the Standpoints of the Business Cycle and the Twin Deficits Hypothesis

Macroeconomic management of a small open economy in a currency board arrangement faces two serious problems: first, under a fixed exchange rate, fiscal policy is the only effective macroeconomic instrument for smoothing out the business cycle; second, the twin deficits phenomenon, if it exists, may jeopardize the stability of the currency board arrangement. This paper uses quarterly seasonally adjusted Eurostat data for the period of 1999–2019, the Hodrick–Prescott filter and a vector autoregression (VAR) to answer the three questions that are of utmost importance to Bulgarian policy-makers: first, is the discretionary fiscal policy of the Bulgarian government procyclical or countercyclical? Second, do the automatic stabilizers in the Bulgarian state budget function properly? Finally, is the twin deficits hypothesis valid for Bulgaria? Our findings imply that the fiscal discretion of the Bulgarian government is procyclical, while the automatic fiscal stabilizers do not work effectively. The first part of the twin deficits hypothesis (the causal link between the fiscal balance and the current account balance) is confirmed but the second part of the twin deficits hypothesis (the positive relationship between the fiscal balance and the current account balance) is rejected for Bulgaria. It may be inferred that both sides of the Bulgarian state budget (revenue and expenditure) need to be improved in order to increase the effectiveness of Bulgaria’s fiscal policy. Low budget deficits (not higher than 3% of GDP) are recommended for improving the current account balance and encouraging economic growth.

The Influence of Taxes on Inflows and Outflows of Foreign Direct Investment

Macroeconomic management of a small open economy in a currency board arrangement faces two serious problems: first, under a fixed exchange rate, fiscal policy is the only effective macroeconomic instrument for smoothing out the business cycle; second, the twin deficits phenomenon, if it exists, may jeopardize the stability of the currency board arrangement. This paper uses quarterly seasonally adjusted Eurostat data for the period of 1999–2019, the Hodrick–Prescott filter and a vector autoregression (VAR) to answer the three questions that are of utmost importance to Bulgarian policy-makers: first, is the discretionary fiscal policy of the Bulgarian government procyclical or countercyclical? Second, do the automatic stabilizers in the Bulgarian state budget function properly? Finally, is the twin deficits hypothesis valid for Bulgaria? Our findings imply that the fiscal discretion of the Bulgarian government is procyclical, while the automatic fiscal stabilizers do not work effectively. The first part of the twin deficits hypothesis (the causal link between the fiscal balance and the current account balance) is confirmed but the second part of the twin deficits hypothesis (the positive relationship between the fiscal balance and the current account balance) is rejected for Bulgaria. It may be inferred that both sides of the Bulgarian state budget (revenue and expenditure) need to be improved in order to increase the effectiveness of Bulgaria’s fiscal policy. Low budget deficits (not higher than 3% of GDP) are recommended for improving the current account balance and encouraging economic growth.

Discretionary vs nondiscretionary in fiscal mechanism – non-automatic fiscal stabilisers vs automatic fiscal stabilisers

The goal of the present study is to increase the intelligibility of macroeconomic phenomena triggered by governmental intervention in economy by means of fiscal policies. During cyclical movements, fiscal policy can play an important role in order to help stabilise the economy. But discretionary policy usually implies implementation lags and is not automatically reversed when economic conditions change. In contrast, automatic fiscal stabilisers (SFA) ensure a prompter, and self-correcting fiscal response. The present study aims to tackle the topic of discretionary vs nondiscretionary characteristic of fiscal stabilisers (SF). In this context, the scope of the research undertaking is to launch a scientific debate over the definitions of the concepts of non-automatic fiscal stabilisers (SfnA) and SFAs. We describe how we can quantify the discretionary and non-discretionary character of the fiscal policy, by the analysis of the structure of the conventional budget balance (SBc), budget balance associated with the current GDP. In the final part of this article, we propose a quantitative equilibrium model for establishing the mathematical prerequisites for an SF to become automatic. Likewise, on the basis of the proposed mathematical model we have performed a qualitative analysis of the influence factors.

Lessons from Thailand's Fiscal Policy

If rules of fiscal sustainability are observed, available fiscal space permits effective countercyclical fiscal programs. The importance of automatic fiscal stabilizers should not be underestimated. The discretionary impact of increased public spending and tax cuts can be amplified if implemented when consumer confidence investor sentiments are high. There is no evidence to support non-Keynesian effects of fiscal policy in Thailand. Unwarranted fears of unsustainable public debt and ultra-conservative fiscal policy has cost the country a lost opportunity for achieving high growth. After the military coups in 2006 and 2014, the Thai economy experienced the lowest economic growth among ASEAN countries. The budget spent on economic services was diverted into defense, increases in public sector's wages, and income transfer payments. The opportunistic political budget model predicts higher fiscal spending by incumbent democratic governments before an election to gain votes. In the case of Thailand, such spending comes after military coups, akin to a military business cycle spending.

Shocking aspects of monetary union: the vulnerability of regions in Euroland

The economic recession in Europe, triggered by the financial crisis of 2008–2009, has rekindled the debate over whether Europe constitutes a viable single currency area. A key issue concerns the relationship between regional economic cyclicity and monetary union: in the absence of a common automatic fiscal stabilization mechanism and with limited geographical mobility of factors, the greater the asymmetry of shocks across the regions making up a currency area, the more that area departs from an optimal single currency space as far as monetary policy is concerned. Our aim in this article is to investigate whether the regions in the Eurozone have become more or less similar in their vulnerability and resilience to economic shocks since the monetary union. Using predictions based on a spatial panel model with random effects, an endogenous spatial lag and spatially autoregressive errors, we find that a common contractionary shock across the Eurozone has its biggest impact on the most geographically isolated regions, which are precisely those peripheral regions in Euroland that are suffering the most acute sovereign debt crisis, and which are among the lowest productivity regions of the European Union. The implications of these results for the debate over European monetary and fiscal integration are discussed.

An Analysis of the Functional Effectiveness of the Automatic Stabilisers of Fiscal Policy in China

Granger causality Wald test and impulse response analysis were employed to test the functional effectiveness of automatic stabilisers of fiscal policy in China, which revealed that the automatic stabilisers exhibited asymmetries in fiscal revenues and expenditures. In particular, automatic fiscal stabilisers reduced economic fluctuations in fiscal revenue during economic booming and recession. With respect to fiscal expenditures, increases and decreases in central fiscal expenditures occurred during times of economic decline and growth, respectively, and thereby exerted countercyclical smoothing effects on the macro-economy; by contrast, increases and decreases in local fiscal expenditures occurred in accordance with economic developments, amplifying economic expansions or recessions. These differences in spending patterns between central and local governments caused malfunctions in automatic stabilisers that were related to fiscal expenditures. Given the premise that the relationship between central and local fiscal approaches should be rationalised, the fiscal spending policies should focus on investments in the livelihood and improvements in the autonomy of budgetary decisions by local governments.

Automatic Fiscal Stabilisers: What They Are and What They Do

The global financial and economic crisis has revived the debate in the academic literature and in policy circles about the size and effectiveness of automatic fiscal stabilisers. Especially in the euro area where monetary policy is centralised and discretionary fiscal policy making is constrained by the EU fiscal rules, knowing the size and the effectiveness of automatic stabilisers is crucial. While automatic stabilisers are a fairly established concept in the fiscal policy literature, there is still no consensus about their actual nature and their effectiveness. This paper shows that differences in opinion mirror a deeper disagreement over how the budget would look like without automatic stabilisers. This issue is addressed by defining two types of counterfactual budgets giving rise to two different interpretations about the nature of automatic stabilisation. Simulations with a structural model confirm that the degree of smoothing is conditional on how the counterfactual budget, i.e. the budget without automatic stabilisers, is defined.

Decomposing Budget Balances for Austria

Brandner, Diebalek and Kohler-Toglhofer assess fiscal policy in Austria over the period 1976-2004 by decomposing the observed budget balance into: a core balance, estimated by means of an unobserved components model; the effect of automatic fiscal stabilizers (as calculated by the European Commission); the impact of discretionary policy responses to the business cycle, econometrically estimated; and a residual.

Fiscal Union in Europe? Redistributive and Stabilising Effects of an EU Tax-Benefit System

The current debt crisis has given rise to a debate about deeper fiscal integration in Europe. The view is widespread that moving towards a 'fiscal union' would have a stabilising effect in the event of macroeconomic shocks. In this paper we study the economic effects of introducing two elements of a fiscal union: Firstly, an EU-wide tax and transfer system and secondly, an EU-wide system of fiscal equalisation. Using the European tax-benefit calculator EUROMOD, we exploit representative household microdata from 11 Eurozone countries to simulate these policy reforms and to study their effects on the distribution of income as well as their impact on automatic fiscal stabilisers. We find that replacing one third of the national tax and transfer systems by a European system would lead to significant redistributive effects both within and across countries. These effects depend on income levels and the structures of the existing national tax and transfer systems. The EU system would improve fiscal stabilisation especially in credit constrained countries. It would absorb between 10 and 15 per cent of a macroeconomic income shock. Introducing a fiscal equalisation system based on taxing capacity would redistribute revenues from high to low income countries. The stabilisation properties of this system, however, are ambiguous. This suggests that not all forms of fiscal integration will improve macroeconomic stability in the Eurozone.

Automatic Fiscal Stabilisers: What They are and What They Do

The global financial and economic crisis has revived the debate in the academic literature and in policy circles about the size and effectiveness of automatic fiscal stabilizers. Especially in the euro area where monetary policy is centralized and discretionary fiscal policy making is constrained by the EU fiscal rules, knowing the size and the effectiveness of automatic stabilizers is crucial. While automatic stabilizers are a fairly established concept in the fiscal policy literature, there is still no consensus about their actual nature and their effectiveness. This paper shows that differences in opinion mirror a deeper disagreement over how the budget would look like without automatic stabilizers. This issue is addressed by defining two types of counterfactual budgets giving rise to two different interpretations about the nature of automatic stabilization. Simulations with a structural model confirm that the degree of smoothing is conditional on how the counterfactual budget, i.e. the budget without automatic stabilizers, is defined.

Fiscal Policy and Interest Rates: The Role of Sovereign Default Risk

Recent events have highlighted the potential importance of nonlinear efiects of flscal variables (notably debt and deflcits) on interest rates: While in times when government solvency is not a concern the standard crowding-out efiects are of moderate magnitude, in times when default risk becomes an issue the interest rate efiects can become very large. This paper provides new evidence on the magnitude of these efiects. For the case when default risk is not a concern, it uses an arbitrage-free term structure model to estimate the dynamic efiects of flscal policy shocks on interest rates along the entire maturity spectrum. For the case when default risk becomes a concern (thereby violating a central assumption of the term structure model), I present evidence based on EMU government bond spread regressions on time-varying efiects of national flscal policies on spreads as well as the time-varying sensitivity of yield spreads to international risk aversion as a function of the state of flscal policy. JEL classiflcation: E6, H6.

From macroeconomic stability to industrial policies and back: The case of Serbia

After the 2008 economic crisis in the whole civilized world the orthodox model of macroeconomic policies has been under revision. Although the last crisis wave in Serbia was not triggered primarily by macroeconomic policies, it forces economists to question the framework for conducting broad policies in conditions of transitional recession. Without automatic stabilizers broad policies lose their purpose, particularly when massive privatization and financial deregulation take place. Hidden fractures of the uncompleted transition and mistakes inherent to the economic policies force us to develop conceptually wider framework applicable during the crisis as well as in the post-crisis period. In the emerging heterodox model industrial policies lead over broad policies (monetary and fiscal, primarily) with extended set of tenets instead of monetary determinism of orthodox model focused exclusively on two tenets, inflation and output gap, both low and stable. In the orthodox model consumer price inflation (CPI) is approximation for inflation and output gap is defined as the distance from the level of output that would prevail in the absence of nominal rigidities of the economic system. Change of the policies framework is an imperative especially for economies that entered the 2008 economic crisis with structural imbalances and low competitiveness. Main manifestations of structural imbalances in Serbia's economy are twin output gaps (transitional gap +gap by definition) and continuous and strong inflation pressures. Unfortunately, structural imbalances could be easily deepened due to financial crisis and the 'run' on the governments and banks in the EU. The shift from the orthodox model to the heterodox one in case of Serbia is not the matter of economic prosperity in terms of output expansion and competitiveness improvement but the matter of survival. Unlike broad macroeconomic policies that affect the whole economy, industrial policies are sector specific. Namely, industrial policies are directed towards output expansion of industries with tradable goods, by promoting certain sectors for import substitution and/or subsidizing certain export oriented sectors. After output increases through industrial policies, broad economic policies come into play. In many ways, in heterodox model the broad policy measures should remain the same. The main promising routes for improvement are new combination of traditional monetary policies and prudential financial regulation and design of better automatic fiscal stabilizers. In monetary policy automatic stabilizers could be developed in many ways. This article suggests currency board as monetary model for Serbia's economy in which stable and competitive exchange rate play the role of automatic stabilizer. This is what this paper tries to do. Consequently, it proceeds in four steps. The first reviews the genesis of the economic crisis in Serbia and identifies the causes of today's vulnerability. The second and most tentative, takes a new heterodox macroeconomic policy framework (industrial policies lead, broad policies follow). The third identifies industrial policies as an important tool for elimination of structural imbalance causes. The fourth identifies the road map for exit from the crisis.

Discretionary Measures and Automatic Stabilizers in the Croatian Fiscal Policy

The role of fiscal policy as a tool to stabilize business cycle fluctuations has been at the center of recent public debates. If governments allow automatic fiscal stabilizers to work fully in a downswing but fail to resist the temptation to spend cyclical revenue increases during an upswing, the stabilizers may lead to bias toward budget positions. This paper assesses to what extent some items of the Croatian central government budget operate to smooth the business cycle. For disentangling automatic stabilizers from discretionary measures, this research relies on the European Commission methodology. Results show that the structural budget balance was on average 1.74% of GDP in deficit in the period between 1995 and 2009. Automatic stabilisation in Croatia is relatively weak and supplemented by discretionary measures, which led to “destabilizing” the economic activity in a pro-cyclical manner in Croatia in several observed periods.

How to Herd Cats: Economic Policy Coordination in the Euro Zone in Tough Times

This paper addresses the issue of fiscal policy coordination in the context of the current crisis. It first aims at clarifying the economic rationale for fiscal policy coordination in a monetary union with decentralized fiscal authorities, and at exploring the foundations of the kind of coordination devices chosen, as well as the incentives and constraints on member states' governments arising from the fiscal rules in the Euro zone, both in tranquil and in stormy economic times. We then proceed with an analysis of the difficulties arising from the heterogeneous nature of the Euro zone. The third section explores some of the possible causes of heterogeneity, with an emphasis on the issue of collective action and country size, with the co‐existence of large and small countries, facing different incentives and constraints, hence tending to adopt divergent strategies in the occurrence of common macro‐economic shocks. The possible evolution in automatic fiscal stabilizers is then addressed, followed by a section documenting the size and structure of national fiscal stimulus packages. The concluding section advocates a better mix of rules and discretionary coordination for fiscal policies in the Euro zone.