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Fiscal policy in Europe: The importance of making it predictable

Lilia Cavallari () and Simone Romano ()

Economic Modelling, 2017, vol. 60, issue C, 81-97

Abstract: This paper provides evidence in support of the hypothesis that fiscal policy is largely anticipated and its effects depend on the extent to which policy is able to affect expectations. Based on a set of 2-country Bayesian VAR models between major European economies, we find that a surprise stimulus triggers expectations of deficit reversals that may crowd out private expenditure. An anticipated stimulus, on the contrary, is found to boost domestic activity in all samples. Moreover, it has positive cross-border effects in 50 percent of the cases. Overall, our findings suggest that fiscal policy is effective when it is not “crowded out” by expectations of reversals. We document such crowding out effects in Italy and France. Finally, we argue that predictability has important consequences for the design of discretionary policy.

Keywords: Fiscal policy; VAR model; Fiscal spillovers; Fiscal multiplier (search for similar items in EconPapers)
JEL-codes: E62 F45 H62 (search for similar items in EconPapers)
Date: 2017
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DOI: 10.1016/j.econmod.2016.09.008

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