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

38 Pages Posted: 15 Feb 2012

See all articles by Marco Buti

Marco Buti

European Commission, DG II

João Nogueira Martins

European Union - Directorate General for Economic and Financial Affairs (DG ECFIN)

Alessandro Turrini

European Commission; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: March 30, 2006

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 optimization 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 debt and deficit. Such practices have greatly contributed to the loss of credibility of EMU’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 Nogueira Martins, João and Turrini, Alessandro, From Deficits to Debt and Back: Political Incentives Under Numerical Fiscal Rules (March 30, 2006). Available at SSRN: https://ssrn.com/abstract=2005229 or http://dx.doi.org/10.2139/ssrn.2005229

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

European Union - Directorate General for Economic and Financial Affairs (DG ECFIN) ( email )

BU-1
Brussels, Bruxelles B-1049
Belgium

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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