University of Groningen
Fiscal policy in the European Economic and Monetary Union
de Jong, Jacobus Frederik Michiel
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de Jong, J. F. M. (2019). Fiscal policy in the European Economic and Monetary Union. University of Groningen, SOM research school.
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Fiscal policy in the European Economic and
Monetary Union
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Publisher: University of Groningen, Groningen, The Netherlands
Printed by: Ipskamp Printing P.O. Box 333 7500 AH Enschede The Netherlands ISBN: 978-94-034-1513-0 eISBN: 978-94-034-1512-3 c 2019 Jacobus F.M. de Jong
All rights reserved. No part of this publication may be reproduced, stored in a re-trieval system of any nature, or transmitted in any form or by any means, electronic, mechanical, now known or hereafter invented, including photocopying or recording, without prior written permission of the publisher.
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Fiscal policy in the European Economic and
Monetary Union
PhD Thesis
to obtain the degree of PhD at the University of Groningen
on the authority of the Rector Magnificus, Prof. E. Sterken
and in accordance with the decision by the College of Deans. This thesis will be defended in public on
Thursday 18 April 2019 at 12.45 hrs.
by
Jacobus Frederik Michiel de Jong born on 19 January 1984
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Supervisors Prof. J. de Haan Prof. J.H. Garretsen
Assessment committee Prof. B. Los
Prof. J-E. Sturm Prof. M. Giuliodori
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Acknowledgements
The genesis of this dissertation is a little amorphous. My first paper (chapter 2) was born out of an internal note at De Nederlandsche Bank (DNB), the empirical core of the second paper (chapter 5) was established during my short secondment at the European Central Bank (ECB), and it was only halfway paper number three that I considered myself to be truly working on a PhD-dissertation. At that point, the contours of something that could be called a manuscript already began to take shape and with the finish line in sight, the motivation to work on the fourth and final paper was maximal.
Notwithstanding the relatively painless process the writing of this thesis turned out to be, I could not have completed it just by myself. I greatly appreciate the possibility given to me by DNB to meander my way through towards completing my PhD. On a more personal level, my thanks go out to my supervisors Jakob de Haan and Harry Garretsen. With their academic eagle’s eyes, yet their policy maker’s pragmatism, they guided me through the whole process nice and smoothly. I furthermore like to express great gratitude towards my co-authors. Marien Ferdinandusse and Josip Funda not only contributed to the fifth chapter of this the-sis, they also made my secondment to the ECB a greatly enjoyable and productive experience. Of course, Niels Gilbert deserves a special mention here, as we share a lot: half a thesis, to begin with, but also a rather common view on doing research as a policy maker as well as a (not so) secret love for Dutch singers. Even weekend days working on research turned out to be great fun.
Research assistance was provided by several people, see the introductory foot-notes in each chapter, but in particular Rebekka Tselms and Peter Keus cannot go unmentioned here. Peter helped in constructing the datasets used in chapters 2 and
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ii
3, and never complained about modified or additional requests from Niels and my-self. Rebekka provided a great effort in helping to compile the news database used in chapter 4; moreover, thanks to her sportsmanship, I substantially improved my skills at the football table.
Last but definitely not least, I thank my family and friends. In particular, my parents, my sister Janneke and my brother Koen – and their families – for their support and love ever since I am around. No need to say, I deeply cherish the warm love, joi de vivre, travel bug and simply great fun Suzanne gives me every day. And you guys, Jules and Gust, rock on. While at times you do cost me some sleep, the smiles you put on your parents’ faces all the time are indispensable.
Jasper de Jong, February 2019
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Contents
1 Introduction 1
1.1 Motivation and research questions . . . 1
1.2 Outline of the thesis . . . 6
2 Do European fiscal rules induce a bias in fiscal forecasts? Evidence from the Stability and Growth Pact 9 2.1 Introduction . . . 9
2.2 Related literature and hypotheses . . . 12
2.2.1 The SGP . . . 12
2.2.2 Fiscal forecasts and the SGP . . . 15
2.2.3 Related literature . . . 18
2.3 Data description . . . 20
2.3.1 Sources and definitions . . . 20
2.3.2 Statistical properties . . . 22 2.4 Estimation methodology . . . 25 2.4.1 Identification . . . 25 2.4.2 Estimation procedure . . . 27 2.4.3 Instrument selection . . . 29 2.5 Results . . . 30 2.5.1 Main results . . . 30
2.5.2 The role of fiscal councils . . . 31
2.5.3 Robustness . . . 34
2.6 Concluding remarks . . . 36
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iv Contents
3 Fiscal discipline in EMU? Testing the effectiveness of the Excessive Deficit
Procedure 45
3.1 Introduction . . . 45
3.2 Literature review and hypotheses . . . 48
3.2.1 The Stability and Growth Pact . . . 48
3.2.2 Council recommendations and fiscal behavior . . . 50
3.2.3 Related literature . . . 54
3.3 Data description and empirical approach . . . 56
3.3.1 Fiscal forecasts and realizations . . . 56
3.3.2 Database of EDP recommendations . . . 58
3.3.3 Empirical approach . . . 61
3.4 Results . . . 63
3.4.1 First results . . . 63
3.4.2 Financial support . . . 65
3.4.3 Controlling for market pressure . . . 68
3.4.4 Kink in the fiscal reaction function . . . 70
3.4.5 Robustness . . . 70
3.4.6 Size of the recommendation . . . 74
3.5 Concluding remarks . . . 75
Appendix A: Model . . . 77
Appendix B: Tables . . . 79
4 The effect of fiscal announcements on interest spreads: Evidence from the Netherlands 91 4.1 Introduction . . . 91
4.2 Model and data . . . 94
4.2.1 Fiscal events and announcements . . . 94
4.2.2 Econometric model and other data . . . 97
4.3 Results and discussion . . . 100
4.3.1 Baseline results . . . 100
4.3.2 Robustness . . . 102
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Contents v
4.3.4 Different maturities . . . 106
4.3.5 Budget balance improvements versus budget balance dete-riorations . . . 107
4.4 Concluding remarks . . . 108
Appendix . . . 113
5 Public Capital in the 21st Century: As productive as ever? 115 5.1 Introduction . . . 115
5.2 Related literature . . . 117
5.3 Data . . . 120
5.3.1 Construction of the data . . . 121
5.3.2 Statistical properties of the time series . . . 123
5.4 Empirical approach and results . . . 125
5.4.1 Econometric approach . . . 125 5.4.2 VAR models . . . 126 5.4.3 Recursive VARs . . . 135 5.5 Concluding remarks . . . 137 Appendix . . . 138 6 Concluding remarks 145 References 149 Nederlandse samenvatting 165 6.1 Motivatie . . . 165 6.2 Onderzoeksvragen en resultaten . . . 168 6.3 Afsluitende opmerkingen . . . 171
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List of Tables
2.1 Summary statistics, EU27, 2001-2012 . . . 22
2.2 Forecast properties . . . 25
2.3 Main results . . . 32
2.4 Predicting excessive deficits - probit . . . 38
2.5 Predicting excessive deficits - probit, lagged instruments . . . 39
2.6 Role of independent fiscal councils . . . 40
2.7 Pre- vs. post-crisis effects SGP . . . 41
2.8 Main results, sensitivity to outliers . . . 42
2.9 Geographical sensitivity . . . 43
2.10 Final realizations . . . 44
3.1 Homogeneous EDP coefficient . . . 64
3.2 Differentiating w.r.t. financial support programs . . . 66
3.3 Controlling for market pressure . . . 69
3.4 Kink in the reaction function . . . 71
3.5 Descriptive statistics . . . 79
3.6 Only EA12 . . . 81
3.7 Constant samples . . . 82
3.8 Excl. GIIPS and Cyprus . . . 83
3.9 Whole European Union . . . 84
3.10 Pre-crisis versus post-crisis . . . 85
3.11 Initial recommendations . . . 86
3.12 Including year dummies . . . 87 3.13 Only recommendations defined in terms of structural budget balance 88
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viii List of Tables
3.14 Size of the recommendations . . . 89
3.15 Size of the recommendations (excl. ESM observations) . . . 90
4.1 Major and Minor events . . . 96
4.2 Baseline estimation results . . . 101
4.3 Robustness . . . 105
4.4 Negotiations versus final agreements . . . 110
4.5 Different maturities . . . 111
4.6 Positive versus negative events . . . 112
4.7 Overview of selected major events . . . 113
5.1 Selected models . . . 128
5.2 Long-run GDP response to a shock in public capital, recursive esti-mates . . . 136
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List of Figures
2.1 Average forecast errors, 2001-2012 . . . 23
2.2 Distribution of forecast errors, 2001-2012 . . . 24
3.1 A government’s response to EDP recommendations . . . 52
3.2 EDP recommendations over time . . . 60
3.3 Distribution of EDP recommendations, EMU member states, by forecast vintage . . . 60
3.4 Response to EDP recommendations . . . 75
4.1 Major and Minor events over time . . . 97
4.2 Yield spread between Dutch and German ten year sovereign bonds . 99 4.3 Sensitivity of estimation results to the coding of events . . . 103
5.1 Public capital stock, in % of GDP, 1960-2014. . . 124
5.2 General government gross fixed capital formation, average by pe-riod, % GDP . . . 125
5.3 Impulse responses of GDP to a one s.d. public capital shock, euro area130 5.3 Impulse responses of GDP to a one s.d. public capital shock, euro area (continued) . . . 131
5.4 Impulse responses of GDP to a one s.d. public capital shock, non euro area . . . 131
5.4 Impulse responses of GDP to a one s.d. public capital shock, non euro area (continued) . . . 132
5.5 GDP response to a public capital shock, sensitivity analysis . . . 134 5.6 General gov. capital stock, % GDP, alternative assumptions, euro area138
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x List of Figures
5.6 General government capital stock, % GDP, alternative assumptions, euro area (continued) . . . 139 5.7 General government capital stock, % GDP, alternative assumptions,
non-euro area . . . 139 5.7 General government capital stock, % GDP, alternative assumptions,
