Moral Hazard in an Economic Union: Politics, Economics, and Fiscal Gimmickry in Europe

Abstract:     
This paper examines empirically how transparency of the budget process affects fiscal rules and incentives for fiscal gimmickry or creative accounting in the European Union. Using stock-flow adjustment data for EU countries from 1990-2007, we show that pressure from a deficit limit rule as in the Stability and Growth Pact creates incentives for fiscal gimmicks, as does political pressure from the electoral cycle and economic pressure from negative shocks in the business cycle. However, we show that where institutional transparency is higher, these incentives are damped and largely disappear. We infer that fiscal rules do not work well when institutional transparency is low.

Number of Pages in PDF File: 49

Keywords: Political Economy, Transparency, Fiscal Policy, Deficits, Debt Management, Electoral Cycles

JEL Classification: D72, E62, H62, H63

working papers series