Estimating a fiscal reaction function for the South East European countries

The global economic crisis caused a deterioration in the public finances of the South East European countries. Hence, the issue of fiscal sustainability became important not only for the developed EU countries (considering the European debt crisis), but also for the SEE region. The aim of this paper is to contribute to the existing literature on fiscal sustainability in the South East Europe by estimating a panel fiscal reaction function. The paper analyses how primary government balances adjust to increasing government debt and to the economic cycle. The main goal is to test whether fiscal policy in these countries tends to react to a sufficient extent to increasing public debt in order to ensure long-term fiscal sustainability. The results of the empirical analysis imply a pro-cyclical fiscal policy in the SEE countries. Regarding fiscal sustainability, the results show that initially a rise in the debt level is followed by a deterioration of the primary balance, which is not consistent with sustainability of public finances. However, in the medium run primary balance seems to adjust to rising debt.