New working paper “Finding the Bottom Line: A Quantitative Model of the EU’s Fiscal Rules and their Compliance” published

A new FIRSTRUN working paper “Finding the Bottom Line: A Quantitative Model of the EU’s Fiscal Rules and their Compliance” has been published today.

The EU’s new fiscal framework is complex. It includes multiple rules and target measures that steer fiscal policy both in the short and long term. While the complexity may be necessary, it is not without problems, as ambiguous fiscal rules are hard to communicate, implement, and enforce. To provide more clarity, this paper uses a dynamic simulation model to quantify the constraint that the rules impose on fiscal policy during consolidations. In particular, the simulator quantifies multiyear adjustment programs that minimize the need of fiscal adjustments while being compliant with the key elements of the framework. By using the European Sovereign Debt Crisis data, the paper shows that the model is consistent with the actual consolidation programs. The paper also finds that revisions of the economic forecasts have a large effect on the simulated adjustments and may increase policy volatility. The positive early 2010 forecasts imply faster minimum adjustments than the weaker ex-post economic data. This feature corresponds well with the recent slowdown of the member states’ fiscal adjustments, and suggests that the policy change is in compliance with the rules.

Author: Tero Kuusi (ETLA)


A program library designed to model the EU’s fiscal rules is now available. The library includes a (stochastic) simulation model that can be used to solve the minimum fiscal effort under the EU’s new fiscal rules.

Download the library here:

Instructions are available inside the zipped package. The library is designed to run on MATLAB.


Output gap uncertainty and the optimal fiscal policy in the EU

FIRSTRUN deliverable 2.7 published: Output gap uncertainty and the optimal fiscal policy in the EU

Using a novel dataset, I quantify the magnitude of the EU-27 countries’ output gap revisions in
2002-2014, and study the implications of this uncertainty for the optimal fiscal policy with a DSGE model. I find that taking into account the output gap uncertainty (i.e. the difficulty to distinguish between cyclical and trend shocks in real time) has large implications for both the net lending and fiscal policy. In the median EU country, the primary net lending turns mildly countercyclical; a feature that is consistent with the data, but contrasts with the procyclical net lending under the full output gap information. The optimal fiscal policy, as measured by the changes in the cyclically adjusted budget balance (CAB), is cautious and turns from strongly to weakly countercyclical because of the uncertainty. During fiscal crises, the CAB is allowed to deteriorate less and the adjustment of the CAB is gradual. The uncertainty generates a substantial amount of cross-country heterogeneity in the dynamics of the total net lending, but not so much in the CAB-based fiscal policy.

Tero Kuusi (ETLA)


Policy brief “Foreign fiscal policy spillovers on Austria”

A new policy brief by Thomas Davoine (IHS) has been published in the journal Wirtschaftspolitische Blätter.

The rationale for fiscal policy coordination within the European Union during normal times is weak because cross-country fiscal policy spillovers are found to be small. During crises, spillovers are larger, either because of constraints on monetary policy or because capital markets are well integrated. With a multi-country general equilibrium model assuming perfect capital market integration, I quantify the medium run impact of foreign fiscal actions on Austria. For instance, if Germany is hit by a negative shock and bails out its private sector, the predicted yearly average GDP loss in Austria is 15% of the yearly GDP loss in Germany. Bailouts in smaller European countries lead to weaker spillovers.

Read the full policy brief here



Iain Begg: Reflecting on the dosh

In its White Paper on the Future of Europe, published in March, the European Commission promised to bring out a series of ‘reflection papers’ on specific topics, the last of which, on the future of the EU’s finances, has now been released. While its main purpose is to inform public debate on how the EU budget should evolve during the next multi-annual financial framework (MFF), due to start in 2021, it also highlights a number of tricky issues deriving from the exit of the UK.

Read more


Iain Begg: Reflecting on how to run EMU more effectively

The European Commission published a reflection paper at the end of May on deepening economic and monetary union. Iain Begg assesses the strategy for reform put forward, writing that the paper is relatively guarded and does not convey an explicit trajectory for the next stages of development of EMU governance. He argues that unless and until there is a greater sense of urgency when it comes to pursuing reforms, the Eurozone will remain vulnerable and could easily drift into a fresh crisis which it is still ill-equipped to resolve.

Read more here


New deliverable on international financial markets and shock absorption in the euro area published

FIRSTRUN deliverable 1.5 published: International financial markets and shock absorption in the euro area

This deliverable investigates the role of financial markets in smoothing the impact of asymmetric shocks in the euro area. The first part offers an assessment of international risk-sharing through international capital markets relative to other mechanisms and compares the euro area to the United States. The second part focuses on the role of international credit markets in providing consumption smoothing, as opposed to inter-state risk-sharing. In doing this, it distinguishes the part driven by policies of the governments from that associated with private sector’s behaviour, and emphasizes the difference between domestic absorption and borrowing in international markets.

Cinzia Alcidi (CEPS)
Paolo D’Imperio (CEPS)
Gilles Thirion (CEPS)


A description of the macroprudential policy block of the NiGEM model published

FIRSTRUN Deliverable 4.6 published: A description of the macroprudential policy block of the NiGEM model

Abstract: In this paper we incorporate a macroprudential policy model within a semi-structural global macroeconomic model, NiGEM. The existing NiGEM model is expanded to include two macroprudential tools: loan-to-value ratios on mortgage lending and variable bank capital adequacy targets. The former has an effect on the economy via its impact on the housing market while the latter acts on the lending spreads of corporate and households. A systemic risk index that tracks the likelihood of the occurrence of a banking crisis is modelled to establish thresholds at which macroprudential policies should be activated by the authorities. Explicit modelling of a systemic risk index also allows for a cost-benefit analysis of macroprudential policy.

Oriol Carreras, NIESR
Philip Davis, NIESR and Brunel University
Iana Liadze, NIESR
Rebecca Piggott, NIESR
James Warren, NIESR


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.

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.