Fiscal Reaction Functions in the EU: A Tale of “r-g” and Whether it Matters
Antonio Afonso,
José Alves and
Joao Jalles
Revue française d'économie, 2021, vol. XXXVI, issue 3, 65-101
Abstract:
We empirically assess fiscal responses for 28 EU countries over the 1995Q1-2021Q2 period. At the same time, we evaluate the importance, for fiscal stance reactions, of notably the difference between economic growth and long-term interest rates. We find a positive response of the primary balance to an increase in government debt for the EU panel, implying an overall Ricardian behaviour. There is also evidence of counter-cyclical fiscal policies having been conducted on average in this geopolitical region. The improvement in the primary balance following increases in the debt-to-GDP ratio gained more relevance in the period after the Global Financial Crisis. Finally, the magnitude of the decrease in the debt-to-GDP ratio following improvements in the primary balance is higher when associated with a positive interest rate-growth rate differential. Such effect disappears for negative interest rate-growth differential. Hence, (r-g) matters, and (r-g)>0 is perceived as a more critical instance.
Date: 2021
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