Fiscal shocks and budget balance persistence in the EU countries from Central and Eastern Europe

Abstract

This article analyses the time series properties of the fiscal balance in the 10 EU countries from Central and Eastern Europe. The persistence of the fiscal balance is analysed by means of unit root tests that account for possible nonlinearities and structural changes. The linear and nonlinear unit root tests find only mild evidence in favour of the stationarity hypothesis, with asymmetric effects present in a few cases. After controlling for structural changes in the Data Generation Processes (DGPs), the results point to stationarity of the series. Thus, in spite of relatively steady headline figures, the budget balance processes in the EU countries from Central and Eastern Europe exhibit substantial instability.

Keywords:

• unit roots
• structural breaks
• budget balance
• EU

JEL Classification:

• C32
• F15

Acknowledgements

We would like to thank Arne Risa Hole, Mai Le and two anonymous referees for valuable comments. The usual disclaimer applies. The views expressed are those of the authors and do not necessarily represent the official views of Eesti Pank. J. C. Cuestas acknowledges financial support from the MICINN (Ministerio de Ciencia e Innovación, Spain) project ECO2011-30260-C03-01. K. Staehr acknowledges financial support from Base Financing grant no. B617A, and Target Financing grant no. SF0140059s12.

Notes

¹ The fulfillment of the intertemporal budget constraint or transversality condition is largely an academic conception of debt sustainability. First, the transversality condition relates to events infinitely far into the future, which makes it difficult to assess its applicability for debt management in a practical framework. Axel Leijonhufvud states this in the following direct way: ‘[W]e had better remember that transversality conditions at an infinite horizon are not to be taken seriously’ (Leijonhufvud, 2011, p. 5). Second, the assumption of interest rates being ‘sufficiently independent’ of the fiscal outcome is unlikely to be satisfied in practice as the interest rate may react strongly to both the budget balance and the debt stock. Finally, the implicit assumption of unchanged government behaviour infinitely far into the future is also unsatisfactory. Guides to practical fiscal management will typically not include a reference to the transversality condition, but instead focus on the accumulation and financing of debt in the short or medium term (Budina and van Wijnbergen, 2007; Balassone and Franco, 2010; EC, 2010, sec. I.4).

² Variable code = gov_q_ggnfa (quarterly nonfinancial accounts for general government), downloaded on 28 November 2010.

³ The use of seasonally adjusted data is controversial, in particular when analysing real business cycles (Ghysels, 1988; Barsky and Miron, 1989; Braun and Evans, 1995). We have nevertheless chosen to apply seasonal adjustment as the size and power of Augmented Dickey–Fuller (ADF)-type tests may be affected markedly by the presence of seasonality in the data (Demetrescu and Hassler, 2007).

⁴ The nonlinear response to positive and negative shocks in the Baltic States may also be detected in Figure 1 and is likely connected with the extreme fluctuations in GDP growth experienced in the countries. Improvements in the budget balance during the boom until 2007 were short-lived as budget surpluses were followed by supplementary budgets that increased spending and reduced taxes. Episodes of budget balance deteriorations – in particular after the crisis in 2008–2009 – seem to have lasted longer, possibly due to the depth of the downturns. See Aslund and Dombrovskis (2001, Ch. 1) for the case of Latvia.