This thesis examines the influence of the cyclical position on discretionary fiscal policy in twenty Western countries in the time period 1960-2004.
The first chapter discusses economic theories related to the concept. A traditional Keynesian view of economic fluctuations is presented, saying that economic fluctuations should be avoided and that counter-cyclical fiscal policy is one way of dealing with the problem. This is then contrasted with several objections. Real business cycle theory doubts the adversity of fluctuations; from this point of view, there is nothing to gain from active stabilisation. The possible efficiency of fiscal policy can be doubted, for example, the Monetarist school claimed that a fiscal-monetary policy mix was a better option, and that active policy was more likely to fail than not. Finally, the intentions and abilities of policy-makers can be questioned; the optimal way to conduct policy may be unrealistic, and governments may have motives that conflict with the general interest.
Four hypotheses are presented. The primary question is whether fiscal policy is conducted in a counter-cyclical manner. I also look for changes in fiscal policy over time. In addition, I test for the influence of public debt and the effects of the political ideology of governments.
The second chapter deals with measuring fiscal policy. Four different approaches are considered, leading to six different numerical indicators of discretionary fiscal policy. The cyclically adjusted balance, advocated by the OECD, uses country-specific production functions to calculate potential output, and estimates induced responses of economic variables to fluctuations in GDP. Blanchard’s Fiscal Impulse uses unemployment data to adjust for cyclical variation. The indicator developed by Braconier and Holden adjusts using a combination of decomposed GDP data and unemployment. The discretionary budget balance, developed by myself, calculates trend values of parts of the budget not related to social security. The variations among these indicators are in some cases large, and are shown to influence the results of the econometric estimations.
The third chapter concerns the econometric analysis. The hypotheses are formulated as linear equations, and are tested using the fixed effects estimator. Fiscal policy is shown to have a pro-cyclical tendency across all countries. When estimating the equations for countries separately, they are shown to have different characteristics, with pro-cyclical policy still being the dominant trend. The cyclically adjusted balance is shown to give results that deviate from the other indicators, generally indicating a more countercyclical policy.Public debt is found to lead to significantly tighter fiscal policy.
For the remaining two hypotheses, no clear results are found. There are, however, indications suggesting a more pro-cyclical policy in the 1990s than in preceding decades. Conservative parties show a slight tendency to lead a less countercyclical policy, and strong governments appear to have more countercyclical tendencies than governments with weaker parliamentary support.