169 - Did fiscal policy makers know what they were doing? Reassessing fiscal policy with real-time data

DNB Working Papers
Publicatiedatum 7 april 2008

Empirical fiscal policy reaction functions based on ex post data cannot be said to describe fiscal policymakers intentions, since they utilise data which did not exist when their decisions were made. A characterisation of what fiscal policymakers were trying to do requires real time data. This paper compares fiscal policy reaction functions for 14 European countries over the period 1994-2006 using both types of data. We exploit the information contained in real-time and ex post data and develop a new approach to estimate the automatic and discretionary fiscal policy responses to changing economic conditions. This avoids the uncertainties and inaccuracies associated with filtering the data upfront in an attempt to estimate potential output or the structural budget. We find that the often commented upon pro-cyclicality of discretionary policy arises only with ex post data; the real time data suggests that policymakers are seeking to run counter cyclical discretionary policy, but find it hard to do so in practice due to data constraints. Compared to elsewhere in the literature, our model yields lower estimates of the automatic fiscal response and stronger estimates of the discretionary fiscal response to an output gap. JEL Codes: E62 (Fiscal Policy); E61 (Policy Design and Consistency) Keywords: Fiscal Policy, Real Time Data, Discretion