Fiscal Policy and Fiscal Rules in the European Union

Abstract

This paper discusses the theory and practice of counter-cyclical fiscal policy to draw conclusions relevant for the fiscal architecture of the European Union. It starts by reviewing major lines of criticism on counter-cyclical fiscal policy, such as the existence of various lags, versions of Ricardian equivalence, non-Keynesian effects of fiscal policies and public choice considerations leading to asymmetry in the use of fiscal instruments. The paper then focuses on factors hampering implementation of a counter-cyclical fiscal policy. First, estimates of counterfactual variables – current and future – that are needed for running the policy are subject to significant margins of uncertainty. Second, relationships between national income on the one side and public revenues and spending on the other side tend to be unstable. Third, precise and timely measures of fiscal positions are largely non-existent. Finally, political requirements for an effective counter-cyclical policy are not met. The pre-Maastricht experience of EU countries, with a massive buildup of public debt despite fiscal-friendly environment, suggests a need for fiscal rules to avoid Argentina-like debt crises. Diverging initial positions of countries call for flexible approach as to the time needed to conform but not for relaxation of the rules, as it recently happened to the Stability and Growth Pact.