Hooverism, hyperstabilisation or halfway-house?: describing fiscal policy in Central and Eastern European EU members

Framework for identification of fiscal policy objectives: empirical evidence from the new EU member states

How can the right targets of a fiscal policy be determined? What is the practical application of the quadratic cost minimization models for the fiscal authorities? What do the empirical results imply for the nature of fiscal policy in the new EU member states?

The paper offers a new approach for solving the dilemma of selection of the right objectives that should be pursued by fiscal authorities. The problem originates from the existing incoherency among the goals that the fiscal policy could be used for. In particular, a decision should be made whether the budget balance or output stabilization would be a priority. As a possible solution, the authors propose and test empirically the application of a practically proven approach used largely in forming monetary policy. They derive an optimal control model in which the authorities' decisions are based on minimization of a quadratic loss function subject to a linear constraint describing the behavior of the economy. The paper is organized as follows: the basic derivation of the framework is presented in section 2, section 3 applies the framework to new EU members in Central and Eastern Europe. Finally, conclusions are presented in the forth section.

The empirical part of the paper presents estimates of a simple fiscal policy reaction function for the eight newly admitted EU members during the period 1994-2003. The results are:

for the Czech Republic, Lithuania, Slovakia and Slovenia the model suggests that fiscal policy was not used (or not used effectively) to stabilize output
for Poland fiscal policy is consistent with a significant weight given to output stabilization in the government's objective function, but in these cases, the fit from the model is still relatively modest
the best fit is for Estonia and Latvia where cyclical considerations explain the fiscal activity more than anywhere else

The general conclusion is that under comparatively stringent constitutional requirements, fiscal policy may play a significant stabilizing role for the economy as show by the experience of Estonia.

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Hooverism, hyperstabilisation or halfway-house?: describing fiscal policy in Central and Eastern European EU members