We investigate the consequences of an increase in public spending for trade balances and budget deficits in the European Union, using a panel vector auto‐regression approach. Whereas the literature tends to treat the trade balance/GDP ratio as a single variable, we include exports and imports as separate variables. This allows us to track in more detail the sources of trade balance movements. Further, we use annual rather than quarterly data. This facilitates the interpretation of the shocks and reduces potential anticipation effects of fiscal policy changes. However, the identification assumptions become stronger, and we extensively check their validity. According to our baseline estimate, a 1% GDP increase in public spending produces a 1.2% on impact rise and a 1.6% peak rise in GDP. Rising imports and falling exports are responsible for a fall of the trade balance by 0.5% of GDP on impact and a peak fall of 0.8%. In addition, the spending increase produces a 0.7% impact (and peak) budget deficit, thereby pointing to the potential relevance of the twin deficits hypothesis for the European Union. (JEL: E62, H60)

"Using real-time data from Europe's Stability and Convergence Programs, we explore how fiscal plans and their implementation in the EU are determined. We find that (1) implemented budgetary adjustment falls systematically short of planned adjustment and this shortfall increases with the projection horizon, (2) variability in the eventual fiscal outcomes is dominated by the implementation errors, (3) there is a limited role for 'traditional' political variables, (4) stock-flow adjustments are more important when plans are more ambitious, and (5), most importantly, both the ambition in fiscal plans and their implementation benefit from stronger national fiscal institutions. We emphasize also the importance of credible plans for the eventual fiscal outcomes". Copyright (c) CEPR, CES, MSH, 2009.

"We explore international spill-overs from fiscal policy shocks via trade in Europe. To assess and quantify the channels through which a fiscal expansion stimulates domestic activity, foreign exports, and foreign output, we estimate a dynamic empirical model of government spending, net taxes, and output, and combine its estimates with a panel model of trade linkages across European countries. The baseline estimates of both models are quite robust and statistically significant. Our results indicate that trade spill-overs of fiscal shocks should be taken into account when assessing the character and intensity of economic integration in the European Union." Copyright CEPR, CES, MSH, 2006.

In this article, we review the theoretical consequences of government purchases shocks for both closed and open economies, followed by a discussion of the empirical literature. Next, we provide our own estimates for the EU countries. We find that an increase in government purchases raises output, consumption and investment and reduces the trade balance. However, the stimulating effect is weaker and the trade balance reduction is larger for the more open EU economies, consistent with larger leakage effects. Further, we show that government purchases shocks in large EU economies have non-negligible consequences for economic activity in the main trading partners.Until the early 1980s fiscal policy was widely regarded as a useful tool for economic stabilisation. In response to the oil shocks of the 1970s many countries relied not only on monetary accommodation but also fiscal expansion. However, those active fiscal policies did not prevent widespread increases in unemployment, while at the same time they resulted in high deficits and rising public debts. This demonstrated ineffectiveness of fiscal policies made many economists sceptical about the usefulness of fiscal policy as a tool for macroeconomic stabilisation. Nevertheless, politicians have continued to view an active fiscal policy as a useful instrument for solving their economic problems. Quite recently, though without success, Japan applied large fiscal expansions in an attempt to escape its liquidity trap. Further, after they secured membership of the Euro-area, a number of countries relaxed fiscal policy. Since the beginning of the current crisis, the US have engaged in unprecedented fiscal expansion, much of it associated with the rescue of the financial sector but also a large share spent to support the 'real economy'. In November 2008, the EU presented its European Economic Recovery Plan (EERP) aimed at a cumulative (over the crisis period) discretionary fiscal stimulus of about 1.5% of the EU GDP, with 1.2% of GDP coming directly from the Member States.This article starts by reviewing the theoretical and empirical consequences of an increase in government purchases in closed and open economies. We focus mostly on the short to medium-run consequences of fiscal expansions, because the main question we are interested in is to what extent discretionary fiscal policy is able to stabilise the business cycle. 1 We also present our own estimates for the EU economies of responses to temporary government purchases shocks, paying specific attention to the behaviour We are grateful to Luca Onorante and two anonymous referees for their helpful comments on an earlier version of this article.1 In this respect, our article complements Gemmell et al. (2010) and Heady et al. (2010) who study the long-run effects of fiscal policy, while, moreover, they focus on the long-run economic consequences of the structure of the tax-spending system.