From Deficits to Debt and Back: Political Incentives Under Numerical Fiscal Rules

Posted: 2 Jul 2008

See all articles by Marco Buti

Marco Buti

European Commission, DG II

João Nogueira Martins

affiliation not provided to SSRN

Alessandro Turrini

European Commission; Centre for Economic Policy Research (CEPR)

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Abstract

Under numerical fiscal rules, such as those underpinning EMU, governments have strong temptations to use accounting tricks to meet the fiscal constraints. Given these political incentives, fiscal variables that in the past were regarded as a mere residual acquire a strategic role. This is the case of the so-called stock-flow adjustment (SFA) which reconciles deficit and debt developments. We develop a simple theoretical model where deficits and two distinct SFA components (one that could be used to reduce the deficit figures and the other to impact debt figures instead) are determined as a result of a constrained optimisation by fiscal authorities. Econometric evidence provides results consistent with the model findings. The SFA component related to the purpose to hide deficits rises with the recorded deficit, while the sales of financial assets designed to keep the debt under control rise with both debt and deficit. When deficits are in excess of the 3 percent limit, accounting gimmicks become more sensitive to the size of deficits. The SGP per se does not appear to increase the extent to which higher deficits trigger more accounting gimmicks. However, the SGP seems associated with a more intense use of accounting gimmicks irrespective of the level of deficit. Such accounting practices have greatly contributed to the loss of credibility of Economic and Monetary Union's fiscal rules. If properly implemented, the reformed Pact, which stresses durable adjustment and long-run sustainability, should help curb such perverse incentives.

Keywords: Stability and Growth pact, government accounting, stock-flow adjustment, fiscal gimmicks

JEL Classification: E61, H62, H87

Suggested Citation

Buti, Marco and Martins, João Nogueira and Turrini, Alessandro, From Deficits to Debt and Back: Political Incentives Under Numerical Fiscal Rules. CESifo Economic Studies, Vol. 53, Issue 1, pp. 115-152, 2007, Available at SSRN: https://ssrn.com/abstract=1154445 or http://dx.doi.org/10.1093/cesifo/ifm003

Marco Buti (Contact Author)

European Commission, DG II ( email )

Rue de la Loi 200
Brussels, B-1049
Belgium
+32 2 296 2246 (Phone)
+32 2 299 3505 (Fax)

João Nogueira Martins

affiliation not provided to SSRN

Alessandro Turrini

European Commission ( email )

Office BU-10/113
B-1049 Brussels
Belgium
+32 2 299 5072 (Phone)
+32 2 299 3505 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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