Governments under influence: Country interactions in discretionary fiscal policy

We investigate the interactions between countries of the discretionary component of national fiscal policies (i.e. the cyclically- and interest-adjusted part of fiscal policy), therefore observing and investigating the part of public spending and tax receipts on which governments keep full discretion. Our sample covers 18 OECD countries, during the 1974-2008 period. First, we build a measure of such discretionary fiscal policy, considered as the residual component of a VAR model, and compute the measure for the full sample. Drawing on this new dataset, the second step provides estimates of discretionary fiscal policy interactions between countries of the sample. Our results highlight the existence of interactions between neighboring countries' public decisions, where neighborhood is defined by economic leadership as well as geography. We also find evidence of an opportunistic behavior of OECD countries' governments for the discretionary public spending. Finally, the disciplining device of the European Union fiscal framework is shown to be ineffective.