Changes in the Fiscal Stance and the Composition of Public Spending

The share of public investment relative to consumption expenditure has declined in past decades. Earlier literature has attributed this stylised fact variably to the relative political ease of cutting investment; different cyclical patterns of public investment and consumption; or to EMU’s fiscal rules. We consider the impact of both cyclical and structural changes in the fiscal stance on public spending composition for a panel of EU countries, including individual components of public investment. We find that both cyclically-induced and structural changes in the fiscal stance affect the composition of public spending, with fiscal tightening of both types increasing, not decreasing, the relative share of investment and loosening favouring consumption expenditure. There is, however, some asymmetry in that the gain in investment following a tightening tends to be smaller than the gain in consumption expenditure following a loosening. Of the components of public investment, infrastructure and redistribution respond to cyclical changes in the fiscal stance, while investment in hospitals and schools responds most clearly to structural changes.