Fiscal rule infringement risks: a stochastic characterization of EMU budgets and their discipline

Wouter van der Wielen

No 500867, Working Papers of Department of Economics, Leuven from KU Leuven, Faculty of Economics and Business (FEB), Department of Economics, Leuven

Abstract: With the recent debt crisis, the necessity of effective measures for safeguarding fiscal sustainability has become patent, leading to an intense debate. Most of the debate focuses on strengthening fiscal rules and restoring fiscal imbalances through austerity measures. In this paper, I address two issues impeding the success of these measures: macroeconomic uncertainty and fiscal policy reaction. Specifically, I apply a structural VAR model to characterize the shocks to growth, inflation and interest rates. In combination with the estimation of fiscal reaction functions, this allows for the application of a Monte Carlo-based approach for deriving the distribution of uncertainty of fiscal realizations. Furthermore, the model quantifies fiscal rule infringement risks and the distribution of the adjustment necessary to restore sustainability. The model thus lends empirical support to recent literature emphasizing uncertainty as essential to the appraisal of a country's fiscal position. Results suggest that the Italian debt path is typified by higher intrinsic uncertainty than its European counterparts. Yet, taking into account the behavioral uncertainty of fiscal policy makers, Spain is the most likely country not to live up to the debt brake in the medium-run. This may impel the enforcement of stricter surveillance to hedge against disadvantageous outcomes.

Date: 2015-06
Note: paper number DPS 15.12
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Published in CES - Discussion paper series,, pages 1-56

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Persistent link: https://EconPapers.repec.org/RePEc:ete:ceswps:500867

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