In order to prove that the European Monetary Union (EMU), which is also called the Eurozone, fails, the econometric analysis is used to see how the immediate, independent and proactive macroeconomic policy in smaller economic region is important to achieve in a stable long-run economic growth. This is the reason why Scandinavian nations keep their own monetary policy. The EMU is an ultimately unstable macroeconomic system without a doubt. Unlike the US federal government system, the EU does not have a common fiscal policy on the top of a common monetary policy. Furthermore, the population in the Eurozone is 329 million which far larger than the US population (approx. 250 million). Therefore, the Eurozone must require a federal government with a stronger fiscal enforcement and a huger scale of fiscal distribution system in order to stabilise the system.
Some pro-EU economists claimed that the trade frequency among the EU countries is so high that the business cycle among the Eurozone nations are more likely to be flexible and automatically stabilised. However, in the Eurozone legal systems are quite heterogeneous and the labour mobility is inflexible unlike the USA.
The centralised economic system eventually needs a big government in order to stabilise the system. The centralised big government in a huge size of econmic region suffers from notorious disadvantages. Labour right has to be abandoned in order to induce a frexible labour mobility to reallocate the labourers means of the change in the business cycle. The economy is more planned in order to redistribute the tax and the government expenditure. The reason why the economy has to be more planned in this system is that the monetary policy (interest rate, money supply, and capital investment plans) is no longer able to adjust to stabilise each business cycle in different areas. In addition, the transaction cost and the time consumed are high in this system to organise the fiscal policy.
On the other hand, the decentralised economic system enables the economic regions to stabilise the business cycle, react against the change in the business cycle by the fiscal policy with a smaller and more efficient transaction cost and a shorter time period, and the monetary is effective. Sweden could adjust its own interest rate immediately to react against the sudden shock in the business cycle as seen in 2009. Singapore remains a stable business cycle and long run economic growth with a smaller size government than the other nations. France is famous for a remarkably proactive macroeconomic policy. According to the econometric analysis offered by this short project proved that the proactive macroeconomic policy encourages a stable long run economic growth. This means that France seems to have a strong advantage in it. However, as France has joined the EMU, her proactive policy is more restricted because of the Maastricht treaty which is installed in order to avoid disharmony of the fiscal policy inside the EMU.
The following chapter explains how the regression analysis proved an effect of the proactive fiscal policy on the stable long run economic growth by using a macroeconomic data set based on 143 countries and 38 time periods (annual basis from 1970 to 2007). The data set is downloaded from
Penn-World Table 6.3. GDP is created by multiplying the real GDP per capita (per worker) by the population. Government expenditure (denoted as "kg") is represented by Government Share of Real GDP per capita (RGDPL). Both GDP and Government Expenditure (kg) are natural-logged (denoted as l_GDP and l_kg accordingly).
Firstly, the variable representing the business cycle is created by subtracting "unit specific effects of countries (the different intercepts for countries)" and "time trend", which represent the long run trend from l_GDP as follows:
Then, the residuals are saved and named as "BizCycle" which represents the business cycle. This variable shows that the economy is in the boom when "BizCycle" is positive whilst the economy is in the recession when "BizCycle" is negative.
Secondly, the variable called "the level of fiscal stimulus", which indicates the level of government expenditure, is created by subtracting "unit specific effects of countries (the different intercepts for countries)" and "time trend", which represent the long run trend from l_kg as follows:
Then, the residuals are saved and named as "Fiscal_Stimulus" which represents the business cycle. This variable shows that "Fiscal_Stimulus" is possitve when the government expenditure is higher than the average across the time whilst "Fiscal_Stimulus" is negative when the government expenditure is lower than the average across the time.
At this stage, the variables representing the business cycle and the fiscal stimulus are created. The reason why the residuals are used instead of taking a difference of the GDP and the kg is to use the constant account of change rather than the current account. If we just use the first-difference of thees variables, it is only able to focus on the current account whici is not able to see the comparison with the average across the time period. The current account only compares the change between the current time period and the previous time period. Using the residuals instead of the first-difference does not exactly mean the constant account. However, it is able to see the dynamic impacts of these variables.
Now, in order to create the variable representing the level of proactivity, "Fiscal_Stimulus" is regressed on "the business cycle", and the kagged variables of "the business cycles" which are lagged for 1, 2, 3, 4, and 5 years, the unit specific effects, and the time trend by the fixed effect estimates (OLS) as follows:
The coefficients of the constant (the common intercept for all countries and time periods), time trend, the current business cycle, and the business cycle lagged for 5 years are significant.
The constant is significant because there is a fixed amount of the government expenditure in all countries. The time trend is significant but this variables is included in the estimates to prove effects of the main explanatory variables are strong enough across the time period. The fixed-effect is used to to prove effects of the main explanatory variables are strong enough across countries. Therefore, this OLS enables to prove the main explanatory variables, "BizCycle" and its lags, are strong enough to explain the dependent variable, "Fiscal_Stimulus".
The important figure is that "BizCycle" and "BizCycle_5" are significant. The coefficient of "BizCycle" is negative whereas "BizCycle_5" is possitive. This implies that "Fiscal_Stimulus" increases as the economy gets into the recession compared to the economy in the five years ago. By contrast, "Fiscal_Stimulus" decreases (lower expenditure and/or higher tax)as the economy recovers or gets into the bubble compared to the five years ago. All in all, this formula shows that it decides whether the economy is in recession or boom according to the comparision with the past situation. This is a quite rational explanation of proactivism, and this formula support the theory explaining how the level of fiscal stimulus is determined according to the business cycle.
The fitted values of "Model 3" is saved. The fitted values is named as "ProAct" which represents the estimated "Fiscal_Stimulus" based on the information of the constant, the time trend, "BizCycle" and "BizCycle_5".
Finally, the time trend, which represents a long run trend of the business cycle, is regressed on "ProAct" by the fixed-effect estimates. The time trend is used because this is only a variable showing its value increase by 1 a year.
The random-effect estimates (GLS) are also tried but offered a less significant level of the coefficient of "ProAct" than the fixed-effect estimates (OLS). But the random-effect estimates indicated that it is significant in the 10% siginicance level. On the other hand, the fixed-effect estimates indicated that it is significant in the 5% significance level which econometricians commonly refer to.
"ProAct" is considered as a relatively week variable because there are so many other potential explanatory variables explaining the long run economic growth. Nevertheless, despite this assymption, the coefficient of "ProAct" become significant and positive. This implies that the proactive fiscal stimulus is one of the important variables encouraging a stable long run economic growth.
