Fiscal reaction functions for the advanced economies revisited

Abstract

We revisit the relationship between the primary balances/GDP and debt/GDP ratios (fiscal reaction function, FRF), in the advanced economies, showing that using adequate tests and estimators leads to question the validity of the current consensus. Using data for 1961–2019, we find that long-run FRFs exist only in a small number of advanced economies (Belgium, Germany, Greece, Norway, Portugal and Sweden), with polynomial effects with fiscal fatigue only in Germany. These results warn against the widespread practice of estimating homogeneous polynomial panel FRFs. Limiting the sample to 1961–2007, thus excluding the 2008 crisis and its aftermath, FRFs hold also in Canada, Ireland, Italy (polynomial), Spain and USA, though not in Germany, and the coefficients are generally larger. Particularly, after 2008 European Union countries appear somehow to have been more likely to implement FRFs.