In search of the Iberian business cycle: endogenous fiscal policy and the changing nature of the state, 1945-2000.

Abstract

Both fiscally responsible and irresponsible governments may have fiscal reaction functions which reduce or increase the amplitude and duration of business cycles. This, we suggest, is the key to the pattern of Iberian fluctuations in economic activity since 1945. Underlying these functions are political settlements or their absence; Traumatic political histories or shocks destroy the basis for stabilising fiscal policies. Stability, political ingenuity and luck can create this basis. Whereas in Spain, the ministers behind the 1959 Stabilisation Plan managed eventually to tame the excesses of a militarily directed economy, and the dictator ensured a transition that kept the army’s loyalty, the opposite path was followed in Portugal. Fiscal prudence allowed authoritarian Portugal to match Spain’s spectacular growth rates of the 1950s and 1960s without economic crises, but failure to secure the army prevented a smooth transition from dictatorship. In consequence Portugal experienced more extreme downturns and budgetary policies than Spain after 2000, and the Maastricht/EMU shocks. The two countries followed crossing paths. Macroeconomic instability prevailed in Spain under at least the early Franco, whereas smoothed adjustments (in spite of stronger external shocks) characterized the economy after the democratic transition. The reverse can be observed in Portugal, where macroeconomic stability under the Estado Novo gave way to dramatic fluctuations after the 1974 revolution.