Publication detail

A Fiscal Rule that Has Teeth: A Suggestion for a “Fiscal Sustainability Council” Underpinned by the Financial Markets

Author(s): doc. Ing. Ondřej Schneider MPhil., Ph.D., Petr Hedbavny, Jan Zápal
Type: Articles in refereed journals
Year: 2007
Number: 1
ISSN / ISBN: ISSN 1802-4696
Published in: AUCO-Czech Economic Review
Publishing place: Praha
Keywords: fiscal policy, European Union, sustainability
JEL codes: E6, H6, H87
Suggested Citation:
Grants: Fiscal Policy in Enlarged European Union: Rules vs. discretion.
Abstract: In this paper, we set out to examine an efficient fiscal-policy framework for a monetary union. We illustrate that fiscal policy’s bias toward budget deficit only temporarily ceased at the end of the 20th century as European countries endeavored to qualify for euro-zone membership, which compelled strict limits on budgetary deficits. We then explore which mechanisms might instill a sense of fiscal disciple in governments. We find that most mechanisms suffer from the incentive-incompatible setup whereby governments restrict their own fiscal-policy freedom. We argue that even multilateral fiscal rules, such as the EU’s Stability and Growth Pact, suffer from the same endogeneity flaw. Consequently, we argue that a fiscal rule must incorporate an external authority that would impartially assess fiscal-policy developments. Using U.S. debt and bond-market data at the state level, we show that financial markets represent a good candidate as, vis-à-vis the American states, they do differentiate state debt according to the level of debt. We thus argue for a fiscal institution – what we call the Fiscal Sustainability Council– that would actively bring financial markets into the fiscal-policy process, and we explain the technique whereby this could be effected.
Downloadable: 2007-1_3 Hedbavny, Schneider, Zapal

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