Do EU fiscal rules support or hinder counter-cyclical fiscal policy?

Martin Larch, Eloïse Orseau and Wouter van der Wielen

Journal of International Money and Finance, 2021, vol. 112, issue C

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 (search for similar items in EconPapers)
JEL-codes: C23 E61 E62 H30 H6 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (28)

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Related works:
Working Paper: Do EU Fiscal Rules Support or Hinder Counter-Cyclical Fiscal Policy? (2020)
Working Paper: Do EU Fiscal Rules Support or Hinder Counter-Cyclical Fiscal Policy? (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:112:y:2021:i:c:s0261560620302849

DOI: 10.1016/j.jimonfin.2020.102328

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