Fiscal policy and economic growth: Evidence from Central and Eastern Europe

Abstract

This study aims to estimate the impact of three fiscal instruments (direct tax revenue, indirect tax revenue and government consumption expenditure) on the economic growth of ten new European Union member states from Central and Eastern Europe– Bulgaria, Czechia, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia. We examine the hypothesis about the effect of expansionary fiscal policy on economic growth. The study employs a vector autoregression and annual Eurostat data for the period 2007–2019. Four control variables (the shares of gross capital formation, household consumption, exports in GDP, and the economic growth in the euro area) are included in the model to account for the influence of non-fiscal factors on economic growth. The empirical results indicate that the real output growth rate in the ten new member states of the European Union is negatively affected by direct tax revenue, while economic growth in the euro area, exports and gross capital formation are positively related to economic growth. The results also imply that government consumption and indirect tax revenue have no significant impact on the growth rate of real output of the ten studied countries from Central and Eastern Europe. It may be inferred that policymakers in the new European Union member states can raise economic growth by encouraging exports and investment and by lowering the share of direct tax revenue in GDP. From the three analyzed fiscal instruments (direct taxes, indirect taxes and government consumption expenditure), only one has proven to be effective in the case of the new member countries.