Heterogeneity in the Fiscal Reaction Function. An Empirical Analysis for EU Member States

This paper studies heterogeneity in the fiscal reaction function for European Union members by resorting to the unconditional quantile regression estimation. Based on annual observations for the years from 2005 to 2018 it shows that the level of the covariates is relevant for the heterogenous response measured in terms of the cyclically adjusted primary balance. First, a positive reaction to different levels of debt is visible, which becomes weaker as the debt ratio rises. This indicates sustainable behaviour that peters out for higher indebtedness. Moreover, the fiscal position is poorer in countries with higher life-expectancy and governments seem to run more pronounced pro-cyclical fiscal policy during bad times. These problems question current as well as future policy design particularly against the background of the recent pandemic situation putting additional social and financial burden on the countries. In addition, the level of development matters for the response pattern and the reaction is stronger indicating more fiscal discipline in less developed countries. Finally, our estimations show that the fiscal position improves with the level of educational attainment and the external position.