Hostname: page-component-84b7d79bbc-g7rbq Total loading time: 0 Render date: 2024-07-26T09:24:16.779Z Has data issue: false hasContentIssue false
  • English
  • Français

Does the Structural Budget Balance Guide Fiscal Policy Pro-Cyclically? Evidence from the Finnish Great Depression of the 1990s

Published online by Cambridge University Press:  01 February 2017

Tero Kuusi
Tero Kuusi*
Affiliation:
Research Institute of the Finnish Economy (Etla)
*
E-mail: tero.kuusi@etla.fi
Get access Rights & Permissions [Opens in a new window]

Abstract

In this article, I evaluate the challenges related to the European Commission's output gap method of calculating the structural budgetary position, and assess its bottom-up alternatives in the EU's fiscal framework using the Finnish data for the years 1984–2014. The results reinforce the impression of the limited capacity of the output gap method to predict cyclical changes in real time and suggest that using the output gap method to steer fiscal policy tends to lead to a procyclical policy (stimulus in upturns and austerity in downturns). The bottom-up assessment methods that are based on discretionary fiscal policy measures appear to work better, and using them to steer fiscal policy could make the policy more effective.

Keywords

Structural budget balanceOutput gapFiscal stanceDiscretionary fiscal effortE62H60
Type
Research Articles
Information
National Institute Economic Review , Volume 239 , February 2017 , pp. R14 - R31
Copyright
Copyright © 2017 National Institute of Economic and Social Research

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

This study has been funded from appropriations for assessment and research activities in support of the Government's decision-making, and the Horizon 2020 Framework Programme of the European Union under the grant agreement number 649261 (the FIRSTRUN project). I would like to thank the following for their expert comments: Zsolt Darvas, Marketta Henriksson, Hannu Kaseva, Markku Kotilainen, Harri Kähkönen, Tuomo Mäki, Niku Määttänen, Veli-Arvo Tamminen, Jenni Pääkkönen, Tarmo Valkonen, Vesa Vihriälä and the seminar audience during internal seminars within Etla, the Finnish Ministry of Finance, as well as the FIRSTRUN workshop and the joint EPC – ECFIN – JRC Workshop ‘Assessment of the real time reliability of different output gap calculation methods’ in 2015. The author assumes sole responsibility for the contents of this paper and any errors therein.

References

Barrios, S. and Fargnoli, R. (2010), ‘Discretionary measures and revenues in the run-up to the financial crisis’, European Commission Economic Papers 419.Google Scholar
Begg, I. (2014), ‘Fiscal policy transparency’ in Forssbaeck, J. and Oxelheim, L. (eds), The Oxford Handbook of Economic and Institutional Transparency, Oxford: OUPGoogle Scholar
Begg, I. (2016), ‘Fiscal and other rules in EU economic governance: helpful, largely irrelevant or unenforceable?’, The Horizon 2020 programme FIRSTRUN project deliverable 6.4.Google Scholar
Bergman, U.M. and Hutchison, M.M. (2015), ‘Economic stabilization in the post-crisis world: are fiscal rules the answer?’, Journal of International Money and Finance, 52, pp. 82–101.CrossRefGoogle Scholar
Bergman, U.M., Hutchison, M.M. and Jensen, S.E.H. (2016), ‘Promoting sustainable public finances in the European Union: the role of fiscal rules and government efficiency’, European Journal of Political Economy, 44, September, pp. 1–19.CrossRefGoogle Scholar
Besley, T. (2007), Principled Agents? The Political Economy of Good Government, Oxford University Press.CrossRefGoogle Scholar
Bouis, R., Cournède, B. and Christensen, A. (2012), ‘Implications of output gap uncertainty in times of crisis’, OECD Economics Department Working Papers 977.Google Scholar
Bryson, A. and Forth, J. (2015), ‘The UK's productivity puzzle’, NIESR Discussion Paper No. 448Google Scholar
Carnot, N. and de Castro, F. (2015), ‘The discretionary fiscal effort: an assessment of fiscal policy and its output effect’, European Economy Economic Papers 543.Google Scholar
D'Auria, F., Denis, C., Havik, K., McMorrow, K., Planas, C., Raciborski, R., Röger, W. and Rossi, A. (2010), ‘The production function methodology for calculating potential growth rates and output gaps’, European Economy Economic Papers, 420.Google Scholar
Daly, M.C. and Hobijn, B. (2013), ‘Downward nominal wage rigidities bend the Phillips Curve’, Federal Reserve Bank of San Francisco Working Paper 8.CrossRefGoogle Scholar
Eschenbach, F. and Schuknecht, L. (2002), ‘Fiscal balances and asset prices’, ECB Working Paper 141.Google Scholar
European Commission (2006), ‘Public finances in EMU’, European Economy, 3|2006.Google Scholar
European Commission (2013a), ‘Vade mecum on the Stability and Growth Pact’, European Economy, Occasional Papers, Issue 151.Google Scholar
European Commission (2013b), ‘Report on public finances in EMU 2013’, European Economy, 4|2013.Google Scholar
European Commission (2015), ‘Making the best use of the flexibility within the existing rules of the Stability and Growth Pact’, Communication From the Commission to the EP, the Council, the ECB, the ESC, the CR And the EIB.Google Scholar
European Commission (2016), ‘Vade mecum on the Stability and Growth Pact, 2016 edition’, European Economy, Institutional Papers, Issue 021.Google Scholar
Fernald, J.G. (2014), ‘Productivity and potential output before, during, and after the Great Recession’, Federal Reserve Bank of San Francisco Working Papers 2014–15.CrossRefGoogle Scholar
Fregert, K. and Pehkonen, J. (2009), ‘The crisis of the 1990s and unemployment in Finland and Sweden’, in Jonung, L., Kiander, J. and Vartia, P. (eds), The Great Financial Crisis in Finland and Sweden, Edward Elgar, pp. 158–83.Google Scholar
Golinelli, R.M.S. (2008), ‘The cyclical response of fiscal policies in the euro area. Why do results of empirical research differ so strongly?’, Banca d'Italia Working Papers 654.Google Scholar
Gorodnichenko, Y., Mendoza, E.G. and Tesar, L.L. (2012), ‘The Finnish Great Depression: from Russia with love’, American Economic Review, 102, 4, pp. 1619–44.CrossRefGoogle Scholar
Hallerberg, M., Strauch, R. and von Hagen, J. (2007), ‘The design of fiscal rules and forms of governance in European Union countries’, European Journal of Political Economy, 23, 2, pp. 338–50.CrossRefGoogle Scholar
Havik, K., Mc Morrow, K., Orlandi, F., Planas, C., Raciborski, R., Roeger, W., Rossi, A., Thum-Thysen, A. and Vandermeulen, V. (2014), ‘The production function methodology for calculating potential growth rates and output gaps’, European Economy, Economic Papers, 535.Google Scholar
Hetemäki, M. (2015), ‘Eurokriisin syyt ja euroalueen tulevaisuus [Reasons for the Euro crisis and the future of the Eurozone]’, Kansantaloudellinen aikakauskirja 1.Google Scholar
Hughes Hallett, A. and Jensen, S.E.H. (2012), ‘Fiscal governance in the Euro Area: institutions vs. rules’, Journal of European Public Policy, 19, 5.Google Scholar
IFAC (2013), ‘Assessment of compliance with fiscal rules’, Irish Fiscal Advisory Council Fiscal Assessment Report 1.Google Scholar
Jalava, J., Pohjola, M., Ripatti, A. and Vilmunen, J. (2006), ‘Biased technical change and capital–labour substitution in Finland, 1902–2003’, B.E. Journal of Macroeconomics, 6, 1.Google Scholar
Keränen, H. and Kuusi, T. (2016), ‘The EU's fiscal targets and their economic impact in Finland’, ETLA Working Papers No 33.Google Scholar
Koen, V. and van den Noord, P. (2005), ‘Fiscal gimmickry in Europe: one-off measures and creative accounting’, OECD Economics Department Working Papers, No. 417.Google Scholar
Kremer, J., Rodrigues Braz, C., Brosens, T., Langenus, G., Momigliano, S. and Spolander, M. (2006), ‘A disaggregated framework for the analysis of structural developments in public finances’, ECB Working Paper 579.Google Scholar
Krugman, P. (2013), ‘The pain in Spain is not hard to explain’, Blog post.Google Scholar
Kuusi, T. (2013), ‘Structural change in the information era: perspectives from a multi-sector model of the Finnish Economy’, Dissertation for Aalto University School of Business.Google Scholar
Kuusi, T. (2014, ‘Consolidation under the Europe's new fiscal rules: analyzing the implied minimum fiscal effort’, ETLA Working Papers No 23.Google Scholar
Kuusi, T. (2015), ‘Alternatives for measuring structural budgetary position’, Publication series of the Government's analysis, assessment and research activities 5/2015.Google Scholar
Lane, P. (2012), ‘The European sovereign debt crisis’, Journal of Economic Perspectives, 26, pp. 49–68.CrossRefGoogle Scholar
Luoma, A. and Luoto, J. (2010), ‘The aggregate production function of the Finnish economy in the twentieth century’, Southern Economic Journal, 76(3).CrossRefGoogle Scholar
Marcellino, M. and Musso, A. (2010), ‘Real time estimates of the Euro Area output gap – reliability and forecasting performance’, ECB Working Papers 1157.Google Scholar
Morris, R.S.L. (2007), ‘Structural balances and revenue windfalls – the role of asset prices revisited’, ECB Working Paper Series 737.Google Scholar
Mourre, G., Isbasoiu, G.-M., Paternoster, D. and Salto, M. (2013), ‘The cyclically-adjusted budget balance used in the EU fiscal framework: an update.’ European Economy, Economic Papers, 478.Google Scholar
Murray, J. (2014), ‘Output gap measurement: judgement and uncertainty’, UK Office of Budget Responsibility Working paper 5.Google Scholar
Orphanides, A. and van Norden, S. (2002), ‘The unreliability of output gap estimates in real time’, The Review of Economics and Statistics, 84(4).Google Scholar
Perotti, R. (2011), ‘The “austerity myth”: gain without pain?’, BIS working papers no. 362.Google Scholar
Planas, C. and Rossi, A. (2004), ‘Can inflation data improve real-time reliability of the output gap?”, Journal of Applied Econometrics, 19(1).CrossRefGoogle Scholar
Planas, C. and Rossi, A. (2014), Program GAP: Technical Description and User-manual, version 4.3, Joint Research Centre Technical Reports, European Commission.Google Scholar
Pohjola, M. (2011), ‘Kasvukauden tilinpäätös’ [Account of a period of growth],Kansantaloudellinen aikakauskirja 3.Google Scholar
Portes, J. and Wren-Lewis, S. (2015), ‘Issues in the design of fiscal policy rules’, Manchester School, University of Manchester, 83, pp. 56–86, 09.CrossRefGoogle Scholar
Price, R. and Dang, T.-T. (2011), ‘Adjusting fiscal balances for asset price cycles’, OECD Economics Department Working Papers 868.Google Scholar
Rünstler, G. (2002), ‘The information content of real-time output gap estimates: an application to the Euro Area’, ECB Working Paper 182.Google Scholar
Sacchi, A. and Salotti, S. (2015), ‘The impact of national fiscal rules on the stabilisation function of fiscal policy’, European Journal of Political Economy, 37, C, pp. 1–20.CrossRefGoogle Scholar
Schackleton, R. (2013), ‘Total factor productivity growth in historical perspective’, Congressional Budget office Working Paper 2013–01.Google Scholar
Stock, J.H. and Watson, M.W. (2010), Modeling Inflation after the Crisis. Economic Policy Symposium, Federal Reserve Bank of Kansas City.CrossRefGoogle Scholar
Summers, L.H. (2014), ‘Reflections on the “New Secular Stagnation Hypothesis”’, in Teulings, C. and Baldwin, R. (eds), Secular Stagnation: Facts, Causes, and Cures, London: CEPR Press.Google Scholar
Timmermann, A. (2006), ‘An evaluation of the World Economic Outlook Forecasts’, IMF Working Paper 06/59.CrossRefGoogle Scholar
Virkola, T. (2013), ‘Rakenteellinen budjettitasapaino’ [Structural budget balance], Reports of the Research Institute of the Finnish Economy ETLA, no. 11.Google Scholar
Virkola, T. (2014), ‘Real-time measures of output gap and fiscal policy stance’, Reports of the Research Institute of the Finnish Economy ETLA, no. 37.Google Scholar
Wolswijk, G. (2007), ‘Short- and long-run elasticities. The case of the Netherlands’, ECB Working paper 763.Google Scholar
Wren-Lewis, S. (2013), ‘How not to run fiscal policy: more lessons from the Eurozone’, Blog post (Mainly Macro, 17 October).Google Scholar