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Fiscal Reaction Functions in the EU: A Tale of “r-g” and Whether it Matters

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  • António Afonso
  • José Alves
  • João Tovar Jalles

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.

Suggested Citation

  • António Afonso & José Alves & João Tovar Jalles, 2021. "Fiscal Reaction Functions in the EU: A Tale of “r-g” and Whether it Matters," Revue française d'économie, Presses de Sciences-Po, vol. 0(3), pages 65-101.
    • Handle: RePEc:cai:rferfe:rfe_213_0065
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    Cited by:

    1. Franc Klaassen, Roel Beetsma and Joao Tovar Jalles, 2023. "How do governments respond to interest rates?," Working Papers REM 2023/0280, ISEG - Lisbon School of Economics and Management, REM, Universidade de Lisboa.
    2. António Afonso & José Alves & Olegs Matvejevs & Olegs Tkacevs, 2023. "Fiscal Sustainability and the Role of Inflation," Working Papers REM 2023/0303, ISEG - Lisbon School of Economics and Management, REM, Universidade de Lisboa.
    3. Karsten Staehr & Olegs Tkacevs & Katri Urke, 2023. "Fiscal performance under inflation and inflation surprises: evidence from fiscal reaction functions for the Euro Area," Bank of Estonia Working Papers wp2023-3, Bank of Estonia, revised 20 Jun 2023.
    4. António Afonso & José Alves & Serena Ionta, 2023. "The Effects of Monetary Policy Surprises and Fiscal Sustainability Regimes in the Euro Area," CESifo Working Paper Series 10558, CESifo.

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