Stress testing the EU fiscal framework

Igor Masten and Ana Grdović Gnip ()

Journal of Financial Stability, 2016, vol. 26, issue C, 276-293

Abstract: This study evaluates the efficiency of the cyclically-adjusted budget balance (CABB) as the central gauge in the reinforced European fiscal framework for evaluating fiscal discipline. We do this by means of a simulation experiment. We use an estimated DSGE model to simulate all the macroeconomic data needed to assess the CABB according to the official EC methodology. Additionally, the model contains an expenditure fiscal rule that accounts for non-automatic variation in the budget, which allows us to observe the true discretionary measures of fiscal policy. Our results indicate that the EC methodology frequently fails to identify the true fiscal policy stance and also frequently fails to correctly signal potential violations of the SGP limit on structural deficit. In the latter case triggering corrective fiscal contractions to comply with the SGP results in increased macroeconomic instability. In addition, we show that allowing for a bigger role for stability-oriented discretionary policy and thus relaxing the SGP limit on structural deficit could enhance the stabilization efficiency of fiscal policy without reducing the degree of compliance with the Maastricht Treaty. These conclusions apply to small countries in a monetary union as well as large countries with independent monetary policy.

Keywords: Cyclically-adjusted budget balance; Structural deficit; Fiscal policy; EU fiscal governance; SGP; Great Recession; DSGE; Stress test (search for similar items in EconPapers)
JEL-codes: E61 E62 H62 (search for similar items in EconPapers)
Date: 2016
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finsta:v:26:y:2016:i:c:p:276-293

DOI: 10.1016/j.jfs.2016.07.011

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