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SUMMARY

Deficits and asset prices

Fiscal revenues and government expenditures are affected by asset price changes in ways that are not accounted for by standard cyclical-adjustment methods. Revenues are influenced by capital gains and turnover taxation, as well as by output changes determined by the effect of wealth changes on consumption and investment. And outlays may also be affected if collapsing asset prices prompt fiscal authorities to bail out private-sector balance sheet problems. We point out that these effects can be asymmetric, resulting in deficit and debt biases, and we find support for this phenomenon in panel estimates for a sample of 20 industrialized countries over 1982–2002. The estimated coefficients indicate that 30–40% of the dramatic early 1990s fiscal balance deteriorations in the UK and Sweden was due to asset price effects, with a particularly relevant role for real estate price changes. If financial markets experience boom–bust cycles, prudent management of fiscal windfalls in boom phases is needed to ensure fiscal and financial sustainability in bust phases, and budgetary rules may need to account explicitly for a separate role of asset price-related effects.

— Felix Eschenbach and Ludger Schuknecht