3.3. Estimating the impact of reforms on budgets through the estimation of fiscal reaction
functions
From the prima-facie evidence reported in the previous section there is not strong support to the
view that labour market, product market, or pension reforms were associated with short-term
budgetary costs. However, the analysis so far did not control for other factors that may have
affected government budgets.
A common way to perform such control is to estimate “fiscal rules”, describing the reaction of
fiscal authorities (in terms of chosen levels of budget balances) to key macroeconomic
developments, such as those related to the cycle and the level of debt.39 The strategy followed in
the following analysis is therefore that of augmenting fiscal rules with variables relating to the
implementation of reforms.40 The budgetary impact of reforms can be gauged by looking at the
regression coefficient of the reform variables.
Table 7 reports the results for panel data estimation of fiscal rules. The dependent variable is the
primary CAB, the explanatory variables are the output gap, the debt/GDP ratio and a dummy
variable taking value 1 if reforms were implemented in the current or previous year. Estimates
have been performed separately for the case of labour and product market reforms. In accordance
with existing estimates of fiscal rules for EU countries, results indicate a non-significant response
of fiscal authorities to output gaps and a significant positive response to debt.41 The coefficient of
reform dummies is negative but barely significant in both the case of labour and product market
reforms.
The size of the coefficients is also similar, indicating that in correspondence with both labour and
product market reforms budgets are loosened by about 0.3 GDP points. The analysis does not
permit to distinguish whether this budgetary effect is a direct one or whether it is related to the
objective of policy authorities of winning resistance to reforms by relaxing the budget. It should be
39 The basic idea is that fiscal authorities are motivated by an objective of output stabilization (so that chosen budget
balances should respond positively to expected output gaps) and by a debt stabilization motive (so that a positive
response of budget balances to the existing stock of debt is expected). For the estimation of fiscal rules for EU
countries see, e.g., Von Hagen, Hugues-Hallet and Strauch (2001), Gali and Perotti (2003), European Commission
(2004), Ballabriga and Martinez-Mongay (2004).
40 An alternative analytical strategy is followed in Pirttila (2001) in analysing the impact of reforms in transition
countries (privatisation, price liberalization, trade liberalization) on fiscal adjustment. In that analysis, the change in
the budget balance is regressed against reform variables and on measures of growth, unemployment, private firms’
entry and initial conditions (number of transition years). Results indicate that while privatisation has a significantly
negative impact on the fiscal balance, the impact of price liberalization was significant and positive.
41 However, it has been shown that the coefficients of output gaps and debt of fiscal rules have not been constant
over time (e.g., Gali and Perotti (2003), European Commission (2004), Ballabriga and Martinez-Mongay (2004)).
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