Do EU Fiscal Rules Support or Hinder Counter-Cyclical Fiscal Policy?

50 Pages Posted: 5 Nov 2020

See all articles by Martin Larch

Martin Larch

European Fiscal Board

Eloise Orseau

European Union - European Commission

Wouter van der Wielen

affiliation not provided to SSRN

Date Written: 2020

Abstract

Rather than stabilising aggregate demand, discretionary fiscal policy tends to amplify cyclical fluctuations of output. The commonly accepted reasons are political economy and uncertainty. In the EU, the pro-cyclical nature of discretionary fiscal policy has also been associated with the commonly agreed fiscal rules, which, for some observers, unduly limit the scope for stabilising output. Using panel data covering close to 40 EU and non-EU countries, we provide evidence that the volatility of output gap estimates is not a convincing explanation for pro-cyclical policies. With the exception of very large shocks, discretionary measures remain ill-timed from a stabilisation perspective even when observable and politically more meaningful indicators of the cycle are used. We also show that deviations from fiscal rules and the accumulation of government debt foster pro-cyclical fiscal policy. Lawmakers can run discretionary fiscal policy measures based on political economy considerations up to a point. Once debt grows too high, the leeway to stabilise output with discretionary fiscal policy measures fades. Complying with fiscal rules that limit the increase in government debt or keep a steady course in the face of cyclical fluctuation is conducive to counter-cyclical fiscal policy making.

Keywords: fiscal policy, fiscal rules, fiscal stabilisation, counter-cyclical policy, dynamic panel models.

JEL Classification: C230, E610, E620, H300, H620

Suggested Citation

Larch, Martin and Orseau, Eloise and der Wielen, Wouter van, Do EU Fiscal Rules Support or Hinder Counter-Cyclical Fiscal Policy? (2020). CESifo Working Paper No. 8659, Available at SSRN: https://ssrn.com/abstract=3725298 or http://dx.doi.org/10.2139/ssrn.3725298

Martin Larch (Contact Author)

European Fiscal Board ( email )

Belgium
0032 2 2969244 (Phone)

Eloise Orseau

European Union - European Commission ( email )

Rue de la Loi 200
Brussels, B-1049
Belgium

Wouter van Der Wielen

affiliation not provided to SSRN

No Address Available

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