The G-20 Summit at Five by Dervis Kemal;Drysdale Peter;

Author:Dervis, Kemal;Drysdale, Peter;
Language: eng
Format: epub
Publisher: Brookings Institution Press

a. Vertical axis is the correlation between the cyclical components of government spending and GDP (during recent economic crisis).

We look at social indicators for our ten eurozone countries. As expected, the biggest increases in the unemployment rate occurred in Greece, Ireland, Italy, Portugal, and Spain (figure 7-4, panel A). This is largely consistent with the observed increases in domestic conflict, with Greece and Spain truly standing out.

The question now becomes, Did procyclical fiscal policy lead to a larger deterioration in fiscal indicators during the crisis? By analyzing the relationship between the index of fiscal cyclicality and the change in unemployment and the change in domestic conflict, we find that both relationships are positive and statistically significant at, at least, the 10 percent level. In other words, these results are consistent with the idea that a procyclical fiscal response in the eurozone has led to deterioration in social indicators.

This finding, however, could reflect reverse causality. To address this issue, and as we did for Latin American countries above, we compute the fiscal readiness index for our sample of ten eurozone countries. We find a highly significant correlation between the fiscal readiness index and fiscal policy, as captured by the correlation between the cyclical component of government spending and real GDP. This is tantamount to saying that we have a valid instrument. Finally, we find a significant relation between our instrument for fiscal readiness and the duration and intensity of crises. We thus conclude that, indeed, procyclical fiscal policies in some eurozone crises contributed to making the current crisis socially costlier (both in terms of unemployment and social conflict), much as in Latin America before 1998.

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