Working Paper: CEPR ID: DP5312
Authors: Vito Polito; Michael R. Wickens
Abstract: We propose an index of the fiscal stance that is convenient for practical use. It is based on a finite time horizon, not on an infinite time horizon like most tests. As it employs VAR analysis it is simple to compute and easily automated. We also show how it is possible to analyse a change of policy within a VAR framework. We use this methodology to examine the effect on fiscal sustainability of a change in policy. We then conduct an empirical examination of the fiscal stances of the US, the UK and Germany over the last 25 or more years, and we carry out a counter-factual analysis of the likely consequences for fiscal sustainability of using a Taylor rule to set monetary policy over this period. Among our findings are that the recent fiscal stances of all three countries are not sustainable, and that using a Taylor rule in the past would have improved the fiscal stances of the US and UK, but not that of Germany.
Keywords: budget deficits; economic policy; fiscal sustainability; government debt; VAR analysis
JEL Codes: C22; C53; E62; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscal policy changes (E62) | Fiscal sustainability (H68) |
| Index of fiscal stance derived from VAR analysis (E62) | Sustainability of fiscal stance (E63) |
| Taylor rule for monetary policy (E52) | Fiscal stances of the US and UK (E62) |
| Fiscal stance index < 1 (E62) | Change in fiscal policy necessary (E62) |
| Fiscal positions deteriorating (H69) | Fiscal sustainability (H68) |