Author Archives: Pekka Vanhala

Rethinking the governance of economic and monetary union: Should rules continue to rule?

Although the EU economy has returned to a period of stable growth since the Eurozone crisis, several key issues in the governance of economic and monetary union remain unresolved. Drawing on results from the Firstrun project, Iain Begg provides an overview of current concerns and outlines five recommendations to help further the debate.

Read Iain Begg’s blog at


Summary report of the FIRSTRUN project published

The last FIRSTRUN deliverable, D1.7 Summary report of the FIRSTRUN project has been published today.

Executive summary:

FIRSTRUN, or Fiscal Rules and Strategies under Externalities and Uncertainties, is a Horizon 2020 project that has investigated fiscal policy coordination in the EU. This report provides a brief overview of the project and its key findings.

One important research theme of the project has been the effects of cross-country spillovers from economic policies. In addition to spillovers from changes in the level of government spending or taxation, which influence aggregate demand, the project has studied spillovers from “structural fiscal policies”, such as pension reforms, which influence the supply side of the economy.

Both the empirical and model-based results are in line with the view that during “normal times”, fiscal spillovers from changes in the level of government spending or taxation are relatively small. However, spillovers may be much larger during “crisis times”, when the borrowing of many households is constrained and when monetary policy is also possibly constrained by the (effective) zero lower bound. Spillovers also increase when national fiscal policies are coordinated. These results underline the importance of fiscal coordination under special circumstances.

Certain structural reforms also have non-trivial spillover effects via international capital markets. These spillovers do not necessarily require policy coordination from the efficiency point of view, but they do have redistributive implications, e.g. their effects on the extent to which capital market integration benefits different countries.

A related issue is how exactly fiscal policies should be coordinated in a currency union to stabilise output growth and maximise average welfare. The analysis, based on a two-country DSGE-model characterised by country-specific price rigidities and distortions, suggests that the optimal solution would be to use fiscal policies to reduce net export gaps. This result stems from country-specific nominal price rigidities, which imply destabilising fluctuations in the terms of trade over the business cycle.

Another stabilization mechanism relates to cross-country risk-sharing. The FIRSTRUN project has considered private and public risk-sharing mechanisms and compared cross-country risk-sharing in the Economic and Monetary Union (EMU) to risk-sharing across states in the United States. The results show that there is still relatively little cross-country risk-sharing via private capital markets in the EMU. One reason for this is that the cross-border ownership of productive assets remains very limited.

The project has also paid close attention to what is known as “real-time uncertainty”, i.e. uncertainty about the current state of the economy. Real-time uncertainty appears to be very relevant for fiscal policy, because it is particularly difficult to distinguish between cyclical and structural components in economic growth in real time. As a result, the first estimates of variables such as the output gap or the structural deficit, which are key variables to consider when setting the stance of fiscal policy, are often later substantially revised. This has important implications for the optimal fiscal policy as well as the implementation of various EU fiscal rules.

A large part of the FIRSTRUN research was dedicated to evaluating the new, enhanced framework of EU fiscal governance. For example, the approach has been to consider how the new fiscal rules would have constrained fiscal policies during past economic booms and busts. Such analysis requires a clear and comprehensive view of the information that was available at the time the rules would have been applied.

In this regard, one of the main results is that the use of the structural deficit for steering fiscal policy tends to lead to pro-cyclical fiscal policy. Essentially, this is because the output gap method used to assess the structural deficit has a very limited capacity to track cyclical changes in real time.

The project also considered alternative measures for estimating the structural balance, such as the expenditure rule used in the preventive arm of the Stability and Growth Pact (SGP) and the so-called bottom up assessment method used in the corrective arm. The results show that at least in the past, these methods would have been conducive to better fiscal policy than the output gap method.

In a similar vein, FIRSTRUN researchers analysed whether the Macroeconomic Imbalance Procedure (MIP) would have been able to detect increasing macroeconomic risks prior to the 2008 financial crisis and the subsequent recession. The results show that the MIP would have provided moderately useful alerts in terms of crisis prediction before 2009. However, many of the indicators, especially those related to the financial markets, would have been uninformative. This suggests that the MIP Scoreboard could be simplified.

The project also dealt with political and institutional aspects of EU fiscal governance. It raised concerns regarding the erosion of democratic legitimation in EU fiscal governance. Given that fiscal policy has more direct distributive consequences than other areas of policy which have become more technocratic, this may undermine the implicit contract between voters and national governments. In addition, public trust in decision-makers has been shaken. The concept of throughput legitimacy – validating how the EU level decides on the policy demands to be made on member countries – is suggested as one dimension of legitimation to be explored.

Finally, the project has produced new tools in the form of quantitative economic models for designing fiscal policies and developing fiscal coordination mechanisms in the EU.


FIRSTRUN Final Conference 29 Jan 2018

FIRSTRUN Final Conference at CEPS on 29 January 2018:
The Future of EU Fiscal Governance: Stabilisation, rules and spillover effects

Over the course of the past three years, a consortium of prestigious universities and economic policy institutes has worked together to carry out research under the FIRSTRUN project. The research team has produced a large body of scientific papers and policy analysis intended to actively contributing to the debate on EU economic governance.

This conference is an opportunity to present selected outputs of the FIRSTRUN project aiming at better understanding how the current EU governance system works as well as discussing potential changes. The conference comes at a very timely moment when the European Commission will be putting forward a more detailed view about the future of EU economic governance. This view will be presented during the conference by Marco Buti, Director-General for Economic and Financial Affairs at the European Commission.


Keynote: Marco Buti (DG ECFIN): The future of the EU fiscal governance

Tero Kuusi (ETLA): Estimating the output gap in real time: Top-down vs. bottom-up

Cinzia Alcidi (CEPS): Shock absorption in the euro area

Rebecca Piggott (NIESR): Fiscal policy spillovers in NiGEM

Thomas Davoine (IHS): Spillover effects from ageing and structural reforms

Alexandre Lucas Cole (LUISS): Fiscal policy coordination and deleveraging

Maria Siranova (IER SAS): The predictive power of the MIP Scoreboard’s indicators

Iain Begg (LSE): Are fiscal and other macroeconomic policy rules past their ‘sell-by’ date?


Video streams:

Keynote by Marco Buti (DG ECFIN) [slides]

The panel discussion led by Daniel Gros on Fiscal rules & Market discipline


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Also see the CEPS website

Full agenda


Deliverable 2.6: “Enhancing credibility and commitment to fiscal rules” published

FIRSTRUN deliverable 2.6 Enhancing credibility and commitment to fiscal rules has been published today.

Abstract: The objective of this paper is to derive the characteristics of an effective fiscal governance framework, focusing on the incentives that ensure a commitment to the fiscal rules. We study this problem with the use of econometric tools, complementing this analysis with formal modelling through the lens of a dynamic principal-agent framework. Our study shows that both economic and institutional factors play an important role in incentivising countries’ fiscal efforts. Fiscal balances are affected not only by the economic cycle, but, among others, by the level of public debt and the world economic situation. We find that the existence of numerical fiscal rules, their strong legal entrenchment, surveillance mechanisms, and credible sanctions binding the hands of governments have a significant impact on curbing deficits. The relationship between the Commission and European Union (EU) Member States (MS), where the EU authorities act as a collective principal that designs contracts for MS, has elements in common with the assumptions of the principal-agent framework. These are: asymmetry of information, moral hazard, different objectives, and the ability to reward or punish the principal. We use a dynamic principal-agent model and show that to ensure good fiscal performance, indirect benefits should be envisaged for higher levels of fiscal effort. In order to account for the structural differences of exerting effort by different MS, it is efficient to adjust fiscal effort to the level of indebtedness. To ensure a commitment to the rules, MS with difficulties conducting prudent fiscal policies should be required to exert less effort than the MS with more modest levels of debt.

JEL classification: D82, E61, H60

Keywords: Principal-Agent, Moral Hazard, Fiscal Effort, Fiscal Rules, Cyclically-Adjusted Balance

Grzegorz Poniatowski, CASE


Deliverable 3.5 “Medium-run impacts of cross-country transfers through a European Union central budget: a general equilibrium evaluation” published

FIRSTRUN deliverable 3.5 “Medium-run impacts of cross-country transfers through a European Union central budget: a general equilibrium evaluation” has been published today.

The European Union budget mostly redistributes resources across its member countries. Using a multi-country overlapping-generations model covering 14 European countries, I investigate the macroeconomic and labor market impacts of central budget options, each leading to different transfers between governments. Simulations show that one can shift prosperity from country to country, measured as gross domestic product variations, at no efficiency cost nor efficiency gains, as long as the central budget can be operated for free and net recipient countries use the transfers to stimulate economic activity rather than support household income. Failing these conditions, the net deadweight loss caused by the distortionary nature of taxation can reach 5% to 8% of the size of the central budget. Simulations also show that the economic burden of large, one-time asymmetric shocks can be shared by all members of the union with a limited public finance cost. Chief among policy implications is a recommendation for earmarking cross-country transfers.

Thomas Davoine, IHS


Deliverable 4.8 “Implementing macroprudential policy in NiGEM” published

FIRSTRUN deliverable 4.8 “Implementing macroprudential policy in NiGEM” has been published.

This is the second of two papers in which we incorporate a macroprudential policy block within the National Institute’s Global Econometric Model, NiGEM. The first paper provided the theoretical background and description of how NiGEM model is expanded to include two macroprudential tools: loan-to-value ratios on mortgage lending and variable bank capital adequacy targets along with a systemic risk index that tracks the likelihood of the occurrence of a banking crisis. This paper starts from the extensions to NiGEM for the UK, Germany and Italy . We then show counterfactual scenarios, including a historic dynamic simulation of the subprime crisis and the endogenous response of policy thereto, based on the macroprudential block as well as performing a cost-benefit analysis of macroprudential policies. Conclusions are drawn relating to use of this tool for prediction and policy analysis, as well as some of the limitations and potential further research.

Oriol Carreras, NIESR
E. Philip Davis, NIESR and Brunel University
Iana Liadze, NIESR
Rebecca Piggott, NIESR
Ian Hurst, NIESR