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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
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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

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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.

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