Fiscal rules and other rule-based mechanisms in practice: introduction to case studies of four Member States

One of the most striking economic governance trends of recent years has been the increased resort to fiscal rules. In the EU as a whole, the number of fiscal rules recorded by the European Commission in its fiscal rules database has risen nearly tenfold since the early 1990s. Such rules have varied considerably across countries. Nearly all EU Member States have also now established Fiscal Councils as independent agencies to monitor the conduct of fiscal policy.

Starting with the Stability and Growth Pact, the EU has been a prime mover in stimulating rule-based governance. Many of the reforms enacted in response to the years of crisis since 2008 were intended to tie the hands of governments even more by establishing norms not only for fiscal discipline, but also for curbing other macroeconomic imbalances. The changes also provide for more intensive monitoring of national policy-making by the EU level and undeniably constitute a far-reaching package.

The national case studies provide a detailed examination of fiscal and other rules in four EU Member States: Italy, Poland, Slovakia and the UK. Two of these are members of the Euro Area, Poland is a non-Euro signatory of the Fiscal Compact, but the UK, even before the Brexit referendum result, was bound much more loosely by EU rules.

The case studies have examined the application of the rules, drawing on a range of documents and on interviews with public officials responsible for the implementation of the rules and with experts knowledgeable about the respective countries. They sought to explore how the processes and mechanisms of fiscal governance function, the interplay between national and EU rules and what they imply for the coherence of the policy system and, more generally, to investigate the political economy of rules.

Deliverable 6.5: Fiscal rules and other rule-based mechanisms in practice: introduction to case studies of four Member States (LSE, LUISS, CASE, IER SAS)

New research paper on cross-country fiscal policy spillovers and capital-skill complementarity published

A new research paper by Thomas Davoine and Matthias Molnar (IHS) has been published:

Thomas Davoine & Matthias Molnar: Cross-country fiscal policy spillovers and capital-skill complementarity in currency unions. IHS Economics Series, Working Paper No. 329.

Abstract:
We investigate cross-country fiscal policy spillovers through the integration of capital markets in a currency union and allow capital use in production to differ across countries. Following empirical evidence, we assume that production exhibits capital-skill complementarity. Using a multi-country overlapping-generations model calibrated for 14 European Union countries, we find that output spillovers are small with standard tax reforms but can be sizeable with large government spending increases financed by taxes: long run output losses in shock-free countries can amount to a quarter of the losses in countries hit by the spending shock. Conditional and temporary relaxing of the EU debt ceiling rule could benefit the Union as a whole.

 

FIRSTRUN workshop on fiscal adjustment and stabilization policies in the EU

FIRSTRUN workshop on fiscal adjustment and stabilization policies in the EU was held in Warsaw, Poland on 24 March 2017.

Programme:

Firstrun project
Niku Määttänen (ETLA) / Grzegorz Poniatowski (CASE)

Macroprudential tools, transmission and modelling
Phillip Davies (NIESR)

On the Limits of Macroprudential Policy
Marcin Kolasa (NBP and SGH)

Debt deleveraging in the EMU
Alexandre Cole (LUISS)

Towards an EU budget with a stabilization function
David Rinaldi (CEPS)

Analysing the Relevance of the MIP Scoreboard’s Indicators
Tomas Domonkos et al. (SAS BIER)

Towards the Bottom Line: Quantifying the EU’s Fiscal Rules and their Compliance
Tero Kuusi (ETLA)

The role of the U.S federal budget as a risk sharing instrument: new lessons for the Euro Area
Gilles Thirion (CEPS)

New deliverables published

New deliverables published:

D1.4: Endogenous Asymmetric Shocks in the Eurozone: the Role of Animal Spirits (CEPS)

Abstract: Business cycles among Eurozone countries are highly correlated. We develop a two-country behavioral macroeconomic model in a monetary union setting where the two countries are linked with each other by international trade. The net export of country 1 depends on the output gap of country 2 and on real exchange rate movements. The synchronization of the business cycle is produced endogenously. The main channel of synchronization occurs through a propagation of “animal spirits”, i.e. waves of optimism and pessimism that become correlated internationally. We find that this propagation occurs with relatively low levels of trade integration. We analyze the role of the common central bank in this propagation mechanism. We explore the transmission of demand and supply shocks and we study how the central bank affects this transmission. We verify the main predictions of the model empirically.

D2.5: Analysing the Relevance and Predictive Power of the MIP Scoreboard’s Indicators (IERSAS)

Abstract: This research aims to evaluate crisis prediction ability of the Macroeconomic Imbalance Procedure Scoreboard’s headline and auxiliary indicators. We test the indicators separately by employing signals approach and loss and usefulness function of the policymaker and then as one system by estimating limited dependent variable models. We also evaluate the thresholds and estimate their optimal value subject to a policymaker with preferences assigning equal importance to both missed crisis and false crisis prediction errors. Moreover, impact of statistical data revisions on crisis predictions is examined. The results show, that the tested indicators perform better for the euro area in comparison to the non-euro area. The external sector indicators along with the new labour market indicators seem to have the best prediction abilities. Our outcomes also suggest that if the Macroeconomic Imbalance Procedure had been employed as an early warning system before the recession in 2009, it would have provided moderately useful alerts in terms of crisis prediction. However, this would mostly have applied to the EA countries and for only few indicators.

D3.3: Fiscal risk-sharing in response to shocks: New lessons for the euro area from the US (CEPS)

Abstract: Discussions on European integration have been influenced for a long time by the experience of the US, whose unemployment insurance (UI) system is often portrayed as an effective tool to respond to idiosyncratic shocks and one that missing in the euro area (EA). This paper investigates the extent to which this is the case in reality. It first offers empirical evidence that EA member states manage to provide a higher degree of insurance against asymmetric shocks (about 20%) than that provided by the US federal budget, which insures through inter-state fiscal risk-sharing (11%). It also shows that the larger budgets of EA member states do not explain this trend alone. Second, the paper finds that the US UI system is mostly relevant a as stabilisation mechanism in the face of US-wide shocks, rather than idiosyncratic shocks. We explain this by highlighting the institutional features of the US UI system as well as the existence of market mechanisms for inter-state risk-sharing. We draw two main lessons for the EA. First, the same system is unlikely to produce the same effects, given the structural features of the EA economies and the lack of effective market mechanisms. Second, a key role of the US federal UI system is to extend the duration and generosity of unemployment benefits in order support states, this tends to be associated with nation-wide recessions and it is the result of a discretionary Congress decisions rather than automatic mechanisms.

D3.4: Towards an EU budget with an effective stabilisation function (CEPS)

Abstract: This policy paper reviews to what extent EU budgetary tools provide a shock mitigation function and aims at exploring potential avenues to reform them to strengthen their stabilisation role. The EU budget is based on principles of medium-term budgeting, co-financing rules with fixed areas of intervention and a very limited possibility for budgetary reallocations. This rigid system makes EU financial support rather ill-suited to address a situation of fiscal emergency when a member state has to react to shocks. Nevertheless, there is evidence of a growing mandate for a stabilisation function within the EU budget, developed particularly in response to labour market shocks. The Youth Employment Initiative and the European Globalisation Adjustment Fund, despite their modest results, represent a concrete step toward introducing shock mitigation among the objectives of EU expenditure. Flexibility arrangements introduced over recent years within the EU budget also move in the direction of adapting the EU budgetary architecture to make it better suited to medium-term ex post shock mitigation. The revenue side of the EU budget is also found to contribute to stabilisation. We argue that the EU policy design to address stabilisation, as developed so far, is not performing and is not apt to the task. As resistances to enhancing the stabilisation capacity are lower at EU than EMU level, we explore room for reform for the post-2020 budget and propose and integrated approach to boost the responsiveness of the EU budget to unforeseen event throw the establishment of an EU fund for Employment and an extended mandate for the European Union Solidarity Fund.

New deliverable on government debt deleveraging published

A new deliverable on government debt deleveraging by Alexandre Lucas Cole (LUISS Guido Carli), Chiara Guerello (LUISS Guido Carli), and Guido Traficante (European University of Rome) has been published today:

D4.4: Government Debt Deleveraging in the EMU

Abstract: We evaluate the stabilization properties and welfare implications of different government debt deleveraging schemes and instruments for deleveraging in a currency union. In a two-country new-Keynesian DSGE model, with a debt-elastic government bond spread and incomplete international financial markets, we study the effects of government debt deleveraging, under a range of alternative shocks and under alternative scenarios for fiscal policy coordination. We find that greater stabilization is achieved by backloading the deleveraging process and when the two countries reduce the net exports gap. Moreover, taxes are a better instrument for deleveraging compared to government consumption or transfers. Our policy prescriptions for the Eurozone are to reduce government debt more gradually over time and less during recessions and to do so using distortionary taxes, while concentrating on reducing international demand imbalances.

 

FIRSTRUN researchers’ articles published in the National Institute Economic Review

The current issue of the National Institute Economic Review* features several articles by FIRSTRUN researchers.

Simon Kirby (NIESR):
Economic Policy and Surveillance in Europe: Introduction

Iain Begg (LSE):
Fiscal and Other Rules in EU Economic Governance: Helpful, Largely Irrelevant or Unenforceable?

Tero Kuusi (Etla):
Does the Structural Budget Balance Guide Fiscal Policy Pro-Cyclically? Evidence from the Finnish Great Depression of the 1990s

Tomáš Domonkos, Filip Ostrihon, Ivana Šikulová, Mária Širanová (IER):
Analysing the Relevance of the MIP Scoreboard’s Indicators

 

Also see a related article by Jan in’t Veld (DG ECFIN):
A Public Investment Stimulus in Surplus Countries and Its Spillovers in the EA

 

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*) The National Institute Economic Review is the quarterly publication of the National Institute of Economic and Social Research, one of Britain’s oldest and most prestigious independent research organisations.

National Institute Economic Review, founded in 1959, provides a vehicle for publishing and promoting high quality research and debate on economic and related social issues.

National Institute Economic Review, Volume 239, Issue 1, February 2017.

New column on risk sharing across the US and Eurozone

Read Valentina Milano and Pietro Reichlin’s new column Risk sharing across the US and Eurozone: The role of public institutions (VoxEU, 23 January 2017).

Abstract
Risk sharing across the Eurozone is well below the levels observed in other federations, including the US. This column argues that the US achieves more intensive risk sharing largely because of a more integrated financial market, and also that the contribution of public institutions to risk sharing is much higher in the Eurozone than in the US. The reason why the Eurozone needs more fiscal transfers to withstand idiosyncratic shocks is not because these institutions should do more to improve risk sharing, but because delegation of risk sharing to national governments threatens the stability of the currency union.

 

New deliverable on EU fiscal rules published

Deliverable 6.4 by Iain Begg (LSE) has been published today:

Fiscal and other rules in EU economic governance: helpful, largely irrelevant or unenforceable?

Abstract: EU Member States have been pushed to adopt more extensive and intrusive fiscal rules, particularly in the euro area, but also in other EU Member States, yet evidence that they are succeeding is, at best, tentative. The EU level Stability and Growth Pact (SGP) has been – and remains – the most visible such rule, but has been complemented by a profusion of national rules and by new provisions on other sources of macroeconomic imbalance. Much of the analysis of rules has concentrated on their technical merits, but tends to neglect the political economy of compliance. This paper examines the latter looking at compliance with fiscal rules at EU and Member State levels, and at the rule-based mechanisms for curbing other macroeconomic imbalances. It concludes that politically-driven implementation and enforcement shortcomings are given too little attention, putting at risk the integrity and effectiveness of rules.