5.
The Dynamic Behaviour of Budget Components and Output - the
Cases of France, Germany, Portugal, and Spain
Antonio Afonso and Peter Claeys*
5.1 Introduction
In recent years, we have witnessed a worldwide swing towards fiscal profligacy. In the
European Union, this has come somewhat as a surprise as the Maastricht Treaty and
afterwards the Stability and Growth Pact seemed to have put in place a set of fiscal rules
that guarantee the sustainability of public finances. The difficulty in applying the Pact,
first to Portugal and later on to France and Germany, has been followed by a more
widespread breach of the 3% deficit limit in several EU countries. A revised version of
the Pact was adopted in March 2005, and takes a more flexible approach in terms of
curbing excessive deficits over a longer period of time, and pays more attention to
sustainability of public finances. As part of the Lisbon Strategy, considerably more
attention is given to the composition of budget adjustments with a view to promoting
economic growth.
A variety of political and economic factors probably underlie the observed rise in public
deficit and debt ratios. We try to uncover any underlying past trends behind the
development of public finances that may contribute to explaining recent budgetary
outlook in France, Germany, Portugal, and Spain. While the first three countries were
subject to several steps of the Excessive Deficit Procedure, Spain on the other hand could
be seen as an example of more vigorous fiscal management. We are particularly
interested in the underlying causes of the breach of the Pact’s rules by looking into
adjustments in various budget components. At the same time, we look into how these
adjustments contribute to the long-term growth prospects and outlook for the
sustainability of public finances.
To that end, we construct a model-based indicator of structural balance by combining
insights from the growing empirical literature on the effects of fiscal policy - modelled
We are grateful to Luis Costa, Arne Gieseck, Michael Thone, Jürgen von Hagen, Jan in't Veld,
seminar participants at the ECB (Frankfurt), at ISEG/UTL (Lisbon), at the 61st European Meeting of
the Econometric Society (Vienna), and at the DG ECFIN workshop on Fiscal Indicators for EU
Budgetary Surveillance (Brussels) for helpful comments and discussions. Valuable assistance of
Renate Dreiskena with the data is highly appreciated. The opinions expressed herein are those of the
authors and do not necessarily reflect those of the ECB or the Eurosystem. Peter Claeys thanks the
Fiscal Policies Division of the ECB for its hospitality. This research was supported by a Marie Curie
Intra-European Fellowship within the 6th European Community Framework Programme. UECE is
supported by FCT (Fundaçào para a Ciência e a Tecnologia, Portugal), financed by ERDF and
Portugese funds.
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