Budgetary Policies in Europe on the Eve of Monetary Union

This paper presents an econometric analysis of 65 episodes of fiscal adjustment in the OECD from 1960 through 1992. The episodes are the ones that Perotti (1995) has identified as entailing major reductions of previous deficits. The paper estimates the effect on the growth of GDP and of consumption from t+4 of reductions in government expenditures, on the one hand, and increases in taxes, on the other, at time t, t being the date of the episode. The coefficients of the reduced forms estimated may be interpreted as multipliers, and compared with Keynesian hypotheses and non-Keynesian hypotheses. The principal conclusion is that the result depends critically on the breadth and development of financial markets. The episodes are divided into times and countries when credit was constrained, and times and places when it appears to have been less constrained, and times and places when it appears to have been less constrained. (A measure of the extent of household housing mortgages is used for this purpose). The finding is that the multipliers have Keynesian signs when credit was constrained, but become insignificantly different from zero when it was less so. The implication is that classical "crowding out" forces offset the Keynesian dynamic when credit is relatively unconstrained. The article concludes with an application of these results to the context of Monetary Union.