Essays in fiscal policy: political determinants and effects on private consumption

Abstract

The three essays in this study investigate a series of issues recently emerged in the literature on fiscal policy. The first two chapters are more related to each other and are contributions (theoretical the former, empirical the latter) to the Political Economy approach to fiscal policy that has emerged in the last two decades. The third chapter abandons that perspective to investigate fiscal policy no longer from the point of view of its determination, but from the point of view of its effects. The recent contributions investigating the relation between the degree of government fractionalisation and fiscal policy see the strategic interaction between coalition partners as a consequence of their incomplete information. In chapter 1 I propose a complete information model in which it is the lack of binding commitments that makes the decision-making process of a coalition difficult, which is related to the type of institutional environment. This also allows for a better insight into the welfare analysis of delayed stabilisations. I also consider the problem why coalition governments with conflicting fiscal goals exist. My answer is that this happens when economic agents care for some extra economic issue a great deal and there is a strong polarisation on the subject. Some empirical contributions have already answered affirmatively to the question whether the presence of coalition governments favours excessive public spending and fiscal deficits. In Chapter 2 I consider whether it is possible to do better by looking not at the type of government in charge (single party vs. coalition), but at its nature. I distinguish between homogeneous and non-homogeneous governments: the latter are held together only by extra- economic motives, while in the former there is also a common view on economic policy, as is the case not just with single party, but also with a number of coalition governments. By using cluster analysis on data regarding 11 OECD countries from 1960 to 1990 I come to the conclusion that treating homogeneous and non-homogeneous coalitions as two separate items makes more sense, as it isolates those coalitions where a strategic interaction over fiscal policy takes place between partners. Non-homogenous coalitions have a greater probability to be associated with strong positive fiscal impulses, but also with strong negative ones. I argue this is not in contrast with the conclusions of Chapter 1 and Alesina and Drazen (1991). As for Chapter 3, its focus is consumption. In recent years a number of works have considered the possible direct crowding out effect caused by government consumption and embedded it in the neoclassical approach to fiscal policy. The relevance of this effect, however, is debated, and though many have tried to assess empirically how much public consumption substitutes for private consumption, they have come to different conclusions. Here I follow the approach suggested by Darby and Malley (1996), who stress the importance of making a distinction between the various components (defence/nondefence) of government consumption. The regression results obtained using Italian annual data on the 1862-1996 sample confirm that composition matters: the direct crowding out effect is higher when the relative weight of government consumption in nondefence increases. The degree of substitutability has therefore followed an upward trend in the post WW2 period, reaching values as high as 0.67 in the most recent years