Working Paper Series no. 292: Fiscal developments in the euro area beyond the crisis: some lessons drawn from fiscal reaction functions

Abstract

In this paper, we examine whether the fact that governments incorporate an objective of sustainability in their budgetary decisions is an element likely to increase the likelihood of a decrease in their deficit and debt ratios beyond the crisis (over the years from 2010 to 2015). We estimate a fiscal reaction function for the Euro area countries and demonstrate that the discretionary policies seem to be pro cyclical in average, thereby influencing the budget balance in the opposite direction than the automatic stabilizers. Our simulations of these rules over the next five years lead us to conclude that two groups of countries could emerge as regards their respective budgetary situations. On the one hand, some “virtuous” countries whose structural deficits will diminish whatever the “exit crisis” scenario envisaged, whereas on the other side, others will not succeed in stabilizing their national debt ratio, because their discretionary fiscal policy is less pro cyclical.

Gilles Dufrénot and Laurent Paul
October 2010

Classification JEL : C23; H61; H63.

Keywords : euro zone, exit crisis scenario, fiscal policy