DP6758 Did Fiscal Policy Makers Know What They Were Doing? Reassessing Fiscal Policy with Real Time Data.

Author(s): Kerstin Bernoth , Andrew Hughes Hallett , John Lewis

Publication Date: March 2008

Keyword(s): Discretion , Fiscal Policy , Real Time Data

JEL(s): E61 , E62

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP6758.asp.asp

Empirical fiscal policy reaction functions based on ex-post data cannot be said to describe fiscal policymakers intentions because they utilise data which did not exist when their decisions were made. A characterisation of what fiscal policy makers were trying to do requires real time data. This paper compares fiscal policy reaction functions for 14 European countries over the period 1995-2006 using both types of data. We exploit the information contained in real time and ex-post data and develop a new approach to estimating the automatic and discretionary fiscal policy responses to changing economic conditions. This avoids the uncertainties and inaccuracies associated with filtering the data in an attempt to estimate potential output or the structural budget. We find that the often commented on pro-cyclicality of discretionary policy only arises in the ex-post data; the real time data suggests that policymakers have tried to run counter-cyclical discretionary policy, but find it hard to do so due to data constraints. Compared to elsewhere in the literature, our model yields lower estimates of the automatic fiscal responses and stronger estimates of the discretionary responses to the output gap.