Working with US data, Edelberg, Eichenbaum and Fisher (1999) and Burnside, Eichenbaum
and Fisher (2004), Ramey (2006) and Romer and Romer (2007) adopt the event study
approach and identify discretionary actions by studying contemporaneous press reports,
focusing on war-related military spending or on tax changes not related to cyclical conditions.
The first approach suffers from two main limitations; first the use of quarterly data sits
uncomfortably with the typical annual frequency of budgetary exercises; second, discrete
fiscal policy actions are usually prepared over a significant period of time, which opens up the
possibility that output responds to expectations of fiscal shocks, not just to the shocks
themselves. The second approach suffers from some arbitrariness in identifying the relevant
policy episodes, which are large by nature, possibly overlooking other, smaller episodes,
which may have different effects.
These controversies are unlikely to be resolved in the near future. We note that there is no
empirical evidence in favor of the assumption that fiscal policy has no effect. The debate is
about the consumption impact of fiscal policies and on the size of the overall output effect,
which is mostly found to be in the Keynesian direction. 6 Skeptics may argue that fiscal policy
is not very powerful, but they do not claim that it is wholly impotent.
3.2. Policy motivation: the euro effect
That fiscal policy can be used as a macroeconomic policy tool does not mean that
governments do so in an appropriate way. A long tradition has identified a number of lags -
recognition, decision, implementation - which could result in badly timed effects. An equally
long tradition has pointed out that governments may be more motivated by political gains
rather than by economic management concerns. If fiscal policy actions are not driven by a
macroeconomic stabilization motive, it may not be systematically countercyclical.
The question, then, is whether euro area membership affect policymakers’ incentives and, if
so, how. A first place to look at is the SGP. On one hand, it can help governments to resist
pressure from interest groups and therefore improve the quality of fiscal policy. On the other
hand, it reduces the room for maneuver and lead to pro-cyclical policies.
Another consideration is the fact that the exchange rate is no longer available to boost
external competitiveness, with two opposite potential effects on the conduct of fiscal policy.
First, governments may be tempted to use fiscal policy instead of monetary policy to
counteract a temporary competitiveness loss when a euro appreciation reduces domestic
demand. A different case concerns a loss of external competitiveness due to domestic
inflation or to a relative productivity decline. In a monetary union, external competitiveness
can only be restored the hard way, through sustained cost and price moderation or enhanced
productivity gains. Fiscal policy is no longer a substitute to monetary policy.7 Its only
possible macroeconomic contribution is to encourage cost and price moderation, possibly by
restricting demand in goods and labor markets. This would make fiscal policy countercyclical
during upswings and acyclical during downswings as long as the exchange rate is overvalued.
A case in point is Germany over 2000-6.
All in all, the impact of the adoption of the euro on the macroeconomic use of fiscal policy is
ambiguous. We expect more countercyclical action as fiscal policy substitutes for the lost
monetary policy instrument, less use of this instrument in downswings as a result of the SGP,
6 Yet another empirical literature examines the possibility of non-Keynesian effects, whereby a fiscal
expansion (contraction) has contractionary (expansionary) effects. We ignore this small literature as it
seems to concern exceptional events, see Giavazzi and Pagano (1990) and Giavazzi et al. (2000).
7 Tax changes, as enacted in Germany in 2007, may partly mimic a depreciation, but this is not a
macroeconomic use and it does not require any change in the budget balance.