Fiscal convergence and business cycle volatility: An empirical analysis on European Union economies

In the European Union, a number of fiscal rules were realized within the frame of the Maastricht Criteria in 1992. The budget balance-to-GDP ratios of the countries are observed to become close to each other with the implementation of these fiscal rules at the beginning of the 1990s. This is called the fiscal convergence in the literature. The issue of how fiscal policies that provide convergence affect the cyclical fluctuations in the economy is one of the important research topics in the literature. In the study, a regression model is used to examine the effects of the convergence of the budget balances of the EU countries on each other over cyclical fluctuations. Estimations are made by the heterogenous panel co-integration approach, using the data of 15 major European Union countries for the years 1995-2015 (21 years). According to the results of the study, it is seen that the convergence of the budget balances of the countries in regard to compliance to the Maastricht Criteria contributed to the simultaneous decrease of discretion in fiscal policies and, thus, it contributed to the decrease in cyclical fluctuations. This finding remains unchanged and still significant when some control variables are included to the model. On the other hand, an alternative fiscal divergence variable is used as a robustness check for findings, in which the relationship between fiscal convergence and cyclical fluctuations are found to remains unchanged also in models estimated by these fiscal variables.