On the relationship between fiscal plans in the European Union: An empirical analysis based on real-time data

We investigate the interdependence of fiscal policies, and in particular deficits, in the European Union using an empirical analysis based on real-time fiscal data. There are many potential reasons why fiscal policies could be interdependent, such as direct externalities due to cross-border public investments, yardstick competition, tax competition and peer pressure among governments. The advantage of using real-time data is that they better reflect the policymakers’ intentions than revised data. Real-time data allow us to investigate how available information is mapped into policymakers’ plans, while revised data are generally 'polluted' with ad hoc reactions to unexpected developments that have taken place after the plan was made. Controlling for a large set of relevant determinants of primary cyclically adjusted deficits, we find indeed evidence of fiscal policy interdependence. However, the interdependence is rather asymmetrically distributed: the fiscal stances of the large countries affect the fiscal stances of the small countries, but not vice versa.