Academic journal article Public Finance and Management

The Global Financial Crisis and Public Finances in the New Eu Countries in Central and Eastern Europe: Developments and Challenges

Academic journal article Public Finance and Management

The Global Financial Crisis and Public Finances in the New Eu Countries in Central and Eastern Europe: Developments and Challenges

Article excerpt

ABSTRACT

This paper discusses the public finances of the 10 new EU countries from Central and Eastern Europe, with particular emphasis on the effects of the global financial crisis that started in 2008. The budget outcomes have differed markedly across the new EU countries, both before and during the crisis. The direct impact of the crisis on public finances was limited, but the severe downturns have strained public finances and increased debt ratios. Estimations of budget reaction functions reveal that the overall budget balance has, in general, been moderately counter-cyclical, but also that the counter-cyclicality derives entirely from the revenue side. The medium-term fiscal outlook rests, to a large extent, on the prospects for growth. The uncertainties regarding future economic growth and stability in financial markets suggest that several of the new EU countries need to tighten fiscal policies as a medium-term prudential measure.

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1. INTRODUCTION

The global financial crisis built up during 2008 and culminated in the bankruptcy of Lehman Brothers in September 2008. The crisis immediately spilled over to the 10 new EU members from Central and Eastern Europe, i.e. the Czech Republic, Estonia, Latvia, Lithuania, Hungary, Poland, Slovenia and Slovakia, which all joined in 2004, and Bulgaria and Romania, which joined in 2007. Capital inflows to the region retrenched markedly resulting in tighter borrowing conditions from 2008. Domestic demand contracted and export volumes fell, and as a consequence, all countries in the region experienced markedly lower GDP growth from the fourth quarter of 2008.

This paper discusses the impact of the global financial crisis on public finances in the new EU countries from Central and Eastern Europe in the short and medium term. The crisis opened up a dilemma: It increased the appeal to governments of intervening in the economy to curb the downturn, save jobs and limit social problems, but it also exposed fiscal vulnerabilities that constrained the ability of the public sector to play an active role. The crisis posed considerable challenges to the management of public finances in the new EU members from Central and Eastern Europe.

This paper has three main aims. First, it gives detailed information on the fiscal policy response in 2008- 09 to the financing problems and economic downturn in the 10 new EU members following the global financial crisis. Second, the paper divides the fiscal policy responses into automatic stabilizer effects and discretionary policy measures in order to assess the different fiscal priorities. Finally, the paper discusses the challenges of fiscal policy management arising from the crisis, in particular measures to reduce the probability of fiscal crises in short and medium term.

The discussion focuses on the new EU countries from Central and Eastern Europe. These countries have attained high growth rates since the mid-1990s and are regularly classified as emerging economies. They are, however, also members of the EU and their fiscal policy must therefore be managed within the overall institutional framework and rules of the EU, including the Stability and Growth Pact. These countries were among the first to experience budget financing problems following the collapse of Lehman Brothers and in this respect they were ahead of developments in Western Europe, where fast-growing economies in the geographical periphery encountered serious fiscal problems in 2010. A study of fiscal policy in the new EU countries is also instructive because the region overall was among the worst affected by the global financial crash. The region exhibits substantial heterogeneity, which may facilitate inference in the empirical analysis; in 2009 GDP fell between 14 and 18 percent in the Baltic countries, while it grew modestly in Poland.

Since the collapse of Lehman Brothers in 2008, the management of fiscal policies has been a focus of policy debates as well as of economic research. …

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