Working Paper: Determinants of Fiscal RuleReform

Christian Bluth∗

POLIS, University of Cambridge

August 12, 2015

Abstract

This paper investigates the relationship between fiscal rules and aset of economic and political variables. It aims at identifying the driversof fiscal rule reform. It also addresses the questions of why some coun-tries adopt stronger fiscal rules than others. It analysis is based on adataset combining economic, institutional and political variables from1990-2012, covering 25 EU countries. The most important driver offiscal reform is debt service costs, but political variables matter. Rightwing governments are generally less likely to undertake fiscal reform.This paper also finds evidence for the existence of a political cycle offiscal rule reform.

Please note that this is just a working paper version. I amhappy about any comments or suggestions. All errors aremine.

Introduction

The European debt crisis has cruelly exposed the dangers of excessive publicdebt. The root for higher than sustainable amount of debt are deep. Thefallout from the financial crisis – in terms of revenue shortfalls and stimulusexpenditure – explains only a fraction of the overall amount of debt of manyEuropean countries. It amounts to not much more that the straw that breaksthe camel’s back. Had public finances been in a healthy state, they wouldhabe been able to deal with this extra burden. But they were not. The

∗cjb240@cam.ac.uk

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Figure 1: The deficit bias in OECD countries. Source: The Economist,9/5/2012

chief reason for this is the deficit bias, the fact that almost all countries ranstructural deficits almost every year for the last 30 years, as figure 1 clearlydemonstrates.

The origin of the deficit bias is well understood. There is also a goodliterature on policies to address the issue, namely fiscal governance and fiscalrules. Both will be briefly discussed at the beginning of this paper. Butthis research approaches another question: How do we explain the greatobserved differences in adopting these measures? Which factors drive fiscalreforms and which impede it? Which political, economic or institutionalfactors induce a country to adopt a fiscal rule? Why do some countries adoptstrong fiscal rules, others weak ones and some countries find it difficult to

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introduce a fiscal rule at all? How can the observed pattern of fiscal rules beexplained? These are the main questions this paper tries to address. It doesso, by making use of a data panel on 25 EU countries, covering economic,political and to some extent institutional factors from 1990-2012.

The remainder of this paper is organised as follows: The first section givesa brief introduction into the origin of the deficit bias and possible remediesagainst it. Subsequently, I present some stylised facts about fiscal policy andmostly fiscal rules in Europe. Finally, I present the results of my regressionanalysis and the answers to the questions guiding the paper.

1 Explaining the Deficit Bias

Why do countries run structural deficits? Almost every country in Europeexhibited a deficit bias at least over some years of its post-war history. Theextent of deficit bias varied across time and country, but no country wasimmune. What is the cause for governments constantly overspending? Isthere some systemic flaw in democratic decision making processes? Does theextent of the deficit bias depend on political institutions?

These questions have been addressed through a quite extensive researchliterature, forwarding theories and testing them empirically. Their commonground is that the deficit bias arises because policymakers do not completelyinternalise the social costs of their actions. A democratic politician shouldnot be confused with a benevolent social planner. He has his own interestsand objectives which do not necessarily align with the socially optimal objec-tives. Also, a democratic policymaker is subject to elections, which impliesa necessity to stand out in competition and ultimately that at some pointhe will have to leave public office.

This is the core of the time-inconsistency theory of public finances, whichattributes the deficit bias to politicians neglecting the social costs of highdeficits and debt because these costs materialise only in the long-term –when they will be out of office anyway. The time-inconsistency theory is oneof two main – potentially complementary – explanations for the deficit bias.The second strand of literature focusses on the common pool problem whicharises from the conflict of interest groups which determines the allocationof public resources. The most important contributions to both theories willsubsequently be outlined in greater detail. The third section of this sectionis devoted the influence of political institutions on the deficit bias.

1.1 Time-Inconsistency Literature

Time-inconsistency is not a new concept in economics. It was first applied byStrotz (1955) to consumption paths. It describes a situation where the pref-erences of the decision maker change over time in a way that the consump-tion path which was perceived as optimal at one time is inconsistent with

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what is perceived as optimal consumption at another time. Since the 1970s,time-inconsistency has been applied to monetary policy. As Kydland andPrescott (1977) demonstrate, time-inconsistency in monetary policy leads tostructurally higher inflation – and so it is not surprising that economists alsoapplied the concept to structural deficits.

1.1.1 "Tie-Their-Hands" Models

The first publications on time-inconsistency in fiscal policy were Persson andSvensson (1989) and Alesina and Tabellini (1990a,b). These papers adopta similar approach, which one could summarise as a "tie-their-hands" ap-proach: An incumbent government uses the deficit to "tie the hands" of thesucceeding government. Persson and Svensson (1989) state that one inspira-tion for this way of modeling fiscal policy came from the alleged discussionsin the first Reagan administration that the only way to achieve permanentlower government spending was to lower taxes in order to affect the capabil-ities of future congresses and administrations.

All these models use roughly similar set-ups. They are all two-periodmodels, where a government change might occur between the first and thesecond period. Two parties compete to form the government and differ intheir preferences over the provision of public good. However, governmentsdo not always implement their preferences since they also use governmentdebt as a strategic instrument to influence the capabilities of the succeedinggovernment.

In Persson and Svensson (1989), a conservative government is initially incharge. This government favours low levels of public good provision sinceit implies lower tax rates and therefore higher consumption for the agentsin the model. But the actual level of public provision is also influenced bythe initial government’s expectation of whoever will still be in charge in thesecond period. Only if it assumes it will still be in power, it is going to im-plement exactly the policy it should implement according to its preferences.If, however, it expects that the other party – which favours higher levels ofpublic good provision – will be the government in the second stage, it willalter its behaviour: It will opt for higher spending, financed through publicdebt.

In order to understand this counter-intuitive behaviour, let us look at thesituation of the second stage government. The party prefers higher levels ofpublic good provision, but since it has to respect a feasibility constraint,the level it can actually implement depends on state variables, among thempublic debt. Thus, the government from the first period can influence thelevel of public good provision of the second government through the level ofpublic debt. Or differently put, the first period government "ties the hands"of the second government.

Persson and Svensson (1989) has some merits. It abandons the idea of a

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government as a pure social utility maximizer and incorporates an elementof political competition in their model. But the model has its downsides,too. First, it considers a rather special case, the case of a conservative gov-ernment fearing it will be replaced by a more spending-friendly government.The inverse logic does not work in the same model. It is not possible totie the hands of the conservative government through higher spending. Sec-ond, the model is quite sketchy. Elections are not endogenous, voters donot choose the government according to their expected utility from eitherparty being in government. Third, there is no overspending or deficit biasin this model. The conservative government overspends to "tie the hands"of their successors but since the second-period government is forced to lowerits expenditures, the intertemporal budget constraint is respected.

The two models by Alesina and Tabellini (1990a,b) address some of theweaknesses but still use a roughly similar framework. One change con-cerns the way the political competition is modeled. In Alesina and Tabellini(1990a) there is an exogenous probability of government change whereas inAlesina and Tabellini (1990b) a median voter decides on the government asa function of the effects of government policy on his utility level. Anotherdifference is that the two competing parties defer not about the level of gov-ernment spending but about its composition. This way also a conservativegovernment’s hands could be "tied" and the problem works symmetrically.

In Alesina and Tabellini (1990a), governments are still in focus. Thegovernment in the first period choses its spending level as a function of theexogenous probability of being in power in the next period. If the re-electionprobability is low, it will spend more and its spending will be orientatedtowards its preferred type of public good. Thus, once the next governmentcomes into power, it will have less resources to spend on the other type ofpublic good.

One way to think about this is as a competition for intertemporal po-litical capabilities. Ideally, political capabilities should not be exhaustedimmediately but used in a smooth path over time. But since parties differabout the way political capabilities should be used, they would rather ex-haust them quickly as long as they can make sure that they are used in theirpreferred way.

This problem is further developed in Alesina and Tabellini (1990b). Sincethe political process in this paper depends explicitly on voter welfare, it isno longer governments but the preferences of present and future voters thatdetermine the use of public resources. Elections take place and the resultdepends on the identity of the median voter. The median voter in the firstperiod is known but the median voter in the second stage is not. Because ofthis uncertainty the fiscal policy of the second period cannot be foreseen, thisleads to excessive debt and use of public resources in the first period as votersscramble for their share of intertemporal political capabilities. Overspend-ing increases with the distance between the median voter in the first stage

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and the expected median voter in the second stage. Thus, more polarisedeconomies exhibit a larger deficit bias.

These predictions have been empirically tested. Grilli et al. (1991) findthat in OECD countries higher deficits and debt levels are typically associ-ated with more frequent government changes – a finding that is still valid asfor example Debrun and Kumar (2007) confirm the correlation between gov-ernment changes and high debt levels for European Union countries. Grilliet al. (1991) also find that political polarisation is linked to higher deficitlevels but they do not limit their study to this. In addition, they find ev-idence that government fragmentation contributes to higher deficits. AlsoAlt and Dreyer Lassen (2006) show that in countries with a more polarisedpolitical system, political business cycles are more pronounced.

Alesina and Tabellini (1990b) also make propositions how the problemcan be solved. A first best solution could be determined through the method-ology of the veil of ignorance, developed by Rawls (1971). If voters do notknow which position in the society they will occupy at the moment whenthey vote, they will vote in favour of the optimal policy and not be biased bytheir personal pay-offs from a given policy. This solution can be replicatedthrough a fiscal rule. The rule solves the commitment problem that is atthe heart of the deficit bias: Since future voters cannot be prevented fromoverspending, present voters overspend. But if a rule prevents voters fromoverspending at any time, this commitment problem no longer persists.

In the "tie-their-hands" literature, the source of the deficit bias in thesemodels is the inability of current governments to commit future fiscal policyto some sustainable spending path. Rules – as long as they are credible– could solve that problem. In fact, rules may be interpreted as a sort ofagreement between parties likely to become government to commit to someframework perceived as sustainable and to refrain from "tying each other’shands". This however presupposes the possibility of consensus among largeparties on what kind of policies can be considered "sustainable". This is anidea to which we shall come back later.

1.1.2 Short-Sightedness Models

One weakness of the "tie-their-hands" literature is that it may be hard to be-lieve that deliberately limiting a succeeding government is a strong priorityfor an incumbent government. Arguably, even the most machiavellian andselfish politician will have many other priorities before "tying the hands" ofhis successor, above all make sure he wins the next election. Any politicianwill gain little from imposing constraints his successor – the gains from win-ning an election and staying in office, however, are strong and immediate.So it is no surprise that many politicians try to win elections by engaging inpopular spending programmes, cutting taxes and embark in other activities

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that have a detrimental effect on public finances1. The result is similar tothat predicted by the "tie-their-hands" literature: public spending increasesprior to elections and is an increasing function of re-election uncertainty.Thus, countries with more frequent government changes are likely to havehigher structural deficits and consequently higher levels of debt.

More recent papers, of which we here present Manasse (2007) as a repre-sentative paper, develop models that take these considerations into account.Also, their models reflect a different vision of fiscal policy, which is no longerlimited to simple public good provision but also has a role in macroeconomicstabilisation.

In Manasse (2007), the agents’ utility depends crucially on the outputgap and the fiscal policy stance. Ideally, fiscal policy would just be theinverse of the output gap, thus leading to a smoothing of the business cycle.However, the government has some exogenous deficit bias in its objectivefunction which generates a more expansionary fiscal policy than would benecessary.

Since rules can solve this problem, Manasse (2007) compares two differ-ent types of rules. First, he studies a balanced budget rule which only faresbetter than the discretionary policy (with the deficit bias) if the variance ofthe output is smaller than the deficit bias. This is because the balanced bud-get rule also prevents macroeconomic stabilisation which would have welfareenhancing effects. Alternatively, Manasse proposes a rule that uses a rewardscheme. If politicians implement the optimal discretionary policy, they re-ceive a reward of exactly the same magnitude as the personal utility lossfrom not implementing the deficit bias. The reward scheme thus offsets thedeficit bias and ensures that the optimal policy is implemented.

How could such a scheme look like in practice? One could think abouta cyclical rule as it is practiced in Sweden, Germany or Switzerland, wherethe budget has to be close to balance over the business cycle. Thus gov-ernments dispose of the necessary discretion to conduct a counter-cyclicalfiscal policy, but they are forced to reduce spending when the economic sit-uation improves. Thus, one important feature of the political budget cycleand source of the deficit bias, the slowness of policymakers to cut back pub-lic expenditure to a normal size once the economy is stabilised2, would beremoved.

So Manasse (2007) illustrates beautifully the mechanics of the deficitbias. But he does not really explain the origin of the deficit bias by justusing an exogenous term. Nor does the use of an exogenous term offer anyexplanation why the deficit bias varies across countries.

1see Persson and Tabellini (2005), Hallerberg et al. (2010), Alesina et al. (2006) forexample

2Alt and Dreyer Lassen (2006)

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1.2 Common Pool Problems

The time-inconsistency literature offers a wide range of explanations of whypoliticians fail to internalise the future costs of overspending. Much of it,be it to "tie the hands" of their successors or simply "buying" support toremain in power, has to do with elections. It is true that deficits tend to belarger in elections years. But even if one considers only non-election years,the deficit bias still persists. That is why a different, albeit complementary,strand of literature emerged which views the competition for public resourcesas a common pool problem.

A common pool resource is generally defined as a resource that is non-exclusive but rival. Common pool problems are frequent in environmentalor agricultural contexts, where a resource is open to be used by all butcongestion or overexploitation problems arise. A classic example is fish, aresource that is non-exclusive because anyone can fish but also rival becausethere is a limited amount of fish available. The fact that too many peopleuse fish stocks leads to the problem of overfishing. Although the problem ofcommon pool resources has been known for a while, it was Elinor Ostrom’sresearch (e.g. Ostrom (1990)) that turned it into an active research area ininstitutional economics.

Since the problem of public finances is so obviously similar to that of lim-ited common goods, it is not surprising that the analytical framework wassoon applied to explain the deficit bias. The first researchers to do this werevon Hagen and Harden (1995), which I shall treat as exemplary for the com-mon pool approach to public finances. Their model features a governmentcomposed of spending ministers who compete for public resources which theycan use to implement their policy. Any minister tries to obtain the largestpossible share of these resources but internalises only the fraction of the so-cial cost his allocation that has to be paid by his constituency. Because ofthe competition of several ministers, the result is that the government asa whole overuses public resources and generates a deficit bias. This deficitbias is a function of the extra-utility a minister gains from a large budgetand the fraction of the total social costs he internalises. The deficit bias alsoincreases with the number of ministers. At the end of their paper von Hagenand Harden (1995) propose a strong finance minister who will discipline theother ministers. This idea is further developed in the governance approachwhich will be described in more detail in the following chapter.

The characterisation of the deficit bias as the result of a common poolproblem has some advantages. It can explain why the deficit bias increaseswith the number of interest groups and it relies on realistic assumptions overthe motivations of the relevant agents. On the other hand, it is not ableto explain any cyclical pattern of public spending or why the deficit bias isstronger in more polarised societies. This is not necessarily a problem sincethe common pool approach is easily reconcilable with the time-inconsistency

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approach.

1.3 Political Institutions and the Deficit

None of the different theoretical approaches discussed so far did pay anyparticular attention to the role of political institutions. But there is anemerging literature on the economic effects of political institutions, whichdoes not neglect the question of their effect on deficits. This literature doesnot add any new explanations about the origins of the deficit bias, but itmakes predictions about how different political systems shape the incentivesof policymakers. Thus it tries to answer the question whether the deficit biasis stronger in majoritarian or proportional systems or whether the fact that acountry has a presidential or parliamentarian regime has an effect. The mostinfluential researchers in this field are Torsten Persson and Guido Tabellini,who have published two books relevant for our purpose. The first is Perssonand Tabellini (2000), which is largely theoretical and outlines the rationaleof the presumed influence of political institutions. In a second book, Perssonand Tabellini (2005) test their predictions empirically.

First, let us turn to the role of the electoral rules, i.e. the way the elec-torate’s preferences are translated into seats in the legislative assembly. Themost important dimension across which electoral rules vary is the electoralformula, i.e. whether a country uses a proportional, majoritarian or mixedrepresentation in its legislative assembly. Among theorists the effect of theelectoral formula remains disputed. Persson and Tabellini (2000) make noprediction, whereas two other papers, Lizzeri and Persico (2001) and Milesi-Ferretti et al. (2002), expect proportional regimes to provide more publicgood because it is more difficult to target than in the case of majoritarianelections. In practice however, an additional complication comes into play.According to Duverger’s Law (Duverger (1951)), majoritarian systems aremuch more likely to generate single-party governments than proportionalsystems. Hence, in majoritarian systems there is much less need for coali-tions and therefore a lower number of veto players in government. This alsopresents a difficulty in the empirical investigation of the effects of electoralformulas. It is not sensible to estimate the effect independently from theeffect of coalition governments. Persson and Tabellini (2005) find that ma-joritarian countries typically run lower deficits than proportional countries.Also surprising is the magnitude of these effects: in majoritarian countriesdeficits are 2% of GDP less than in proportional countries. Also, budgetsare generally smaller (5% of GDP) than in proportional countries.

This leaves finally the question of the influence of the form of govern-ment, i.e. whether a country is parliamentarian or presidential. The maindifference between the two forms is basically the relationship between thegovernment and legislature. In a presidential regime the government typi-cally does not need the confidence of the parliament and often has the right

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to dissolve the legislature. Persson et al. (1997) argue that the confidencerequirement changes the functioning the the political process as it is a strongincentive for members of the government party to be ultimately supportive.It creates legislative cohesion, which leads to more stable governments. ButPersson et al. (1997) also make the argument that it generates policies thatbenefit the majority of voters and not just a targeted pivotal group. Presi-dential regimes on the contrary focus on pivotal groups and therefore havesmaller budgets and deficits. The empirical evidence collected by Perssonand Tabellini (2005) suggests that the effect of presidential regimes is indeedstrong, reducing the overall size of the budget by 5% of GDP – a result thatis remarkably strong and robust in all their specifications. Also, presidentialcountries typically have smaller deficits.

2 Remedies Against the Deficit Bias

There is more than one way to mitigate the deficit bias. It is only veryrecently that fiscal rules – which can take many forms – have moved in thecentre of attention. Rules are generally not very sophisticated mechanisms.They impose blunt constraints on policymakers. Some people criticise therule approach because policymakers need room for discretion in order to beable to react adequately to political and economic circumstances. A moresophisticated mechanism that does not compromise legitimate political dis-cretion is altering the policymaker’s incentives in a way that they are morealign with that of the population. This could be facilitated through a setof governance provisions which do not exhibit any undesired and rigid prop-erties – the governance approach, to which the next subsection is dedicatedbefore different types of fiscal rules are described.

2.1 The Governance Approach to Fiscal Policy

The governance approach, which is inspired by the influential contributionsof Mark Hallerberg, Rolf Strauch and Jürgen von Hagen, is directly basedon the common pool problem at the origin of the deficit bias. It proposesgovernance arrangements, adapted to political institutions, that facilitate aninternalisation of the social costs of systemic deficits.

According to the governance approach, the solution of the common poolproblem depends on the type of political institutions. Countries with aproportional electoral formula, and therefore more frequent coalitions, shouldadopt the contract approach whereas countries which typically have singleparty governments are best off with the delegation approach3. Let us startwith the delegation approach. The idea is that the competing spendingministers should be brought under the control of the finance minister, who

3Compare Hallerberg and von Hagen (1999); Hallerberg et al. (2007, 2010)

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is charged with the task of ensuring that the budget is sustainable. He issupported in this task by the head of government or prime minister.

The rationale is that the finance minister is less bound to any specialinterests than any spending minister. He should therefore be endowed withstrong agenda setting powers in the initial phase of the budget preparation.Hallerberg and von Hagen (1999) suggest for example that he should nego-tiate the budget with each spending minister individually and not with thegroup of spending ministers. Also, he should have the power to modify eachspending head in the proposition of a spending minister if he likes to, notonly the overall size of the share of the budget allocated to a specific ministry.In the voting phase of the budget, the power of the legislature to modify thebudget proposal should be limited. It is suggested, that the parliament willhave to vote the overall size of the budget first, before the debate on the com-position of public spending is started. Thus, any amendment to the budgetproposal that will result in higher costs needs to contain a proposition wherethese additional funds come from. Also in the implementation phase of thebudget, the finance minister should be able to supervise the execution of thebudget and to intervene if agreed targets are not met.

Such an arrangement, however, would not work properly in a coalitiongovernment. The power of the finance minister might be sufficient to disci-pline the members of his own political party but not the ministers from otherparties involved in the coalition. Therefore Hallerberg and von Hagen (1999)propose the contract approach: When the coalition is formed, the coalitionparties should negotiate budget and spending targets for each year of theirmandate. Such a ceiling prevents negotiations on the composition of thebudget result in a deficit bias. In this approach, the minister of finance hasmerely monitoring powers, as does the parliament. Both the finance minis-ter and the legislature ensure that targets are being met and the contract isrespected.

In Hallerberg et al. (2010), the authors empirically assess the efficiencyof the proposed measures and find that following the adequate governanceapproach reduces the size of the structural deficit and thus leads to moresustainable finances. But it does not eradicate the deficit bias.

In the delegation approach, the underlying assumption is that the financeminister’s objectives (and the prime minister’s, too) align with those of thepopulation. It is probably true to assume that finance and prime ministerare less prone to special interests than the spending ministers but they aresubject to their own biases. Most importantly, both want to win elections.And policymakers may see engaging in spending programmes prior to elec-tions as a vote winning activity. This clearly puts a limit on the discipliningrole of finance or prime minister. Another incentive that may make financeministers in particular deviate from the socially desirable position are careerconcerns. If the finance minister is too restrictive with the spending min-isters, he might not be able to count on their support if he wants to move

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on to a new position. Delegating important powers to the finance ministertherefore only reduces the deficit bias but does not solve the problem.

A similar criticism can be addressed to the contract approach. Nothingprevents the coalition from setting up generous spending targets – in fact, itmakes allocation negotiations easier if the ceilings are not too low. Haller-berg et al. (2010) find that the contract approach is less efficient than thedelegation approach in containing deficits. This might be an explanation forthis phenomenon.

This is not to discredit the governance approach. It has considerablemerits and potentially advantages over the rules approach in leaving a largermargin of discretion to politicians, not constraining them too much in theirresponse to a specific macroeconomic scenario.

2.2 The Rules Approach to Fiscal Policy

As previously described the basic rationale of the rules approach is quitesimple. Rules impose strong constraints on policymakers and force them toconduct fiscal policy in a way that is consistent with the rule. However,the rules approach is not a unified one. Many different types of rules havebeen proposed and practiced and the choice of a rule is strongly influencedby a particular political vision of the role of fiscal policy. In this section, Idescribe the main types of rules that are used in Europe and comment ontheir advantages and downsides:

• Golden Rule: A relatively weak but frequently used rule. It stipulatesthat over the business cycle the government is only allowed to incurnew debt in order to finance investments. In practice, it is not easyto define what exactly an investment in the sense of the rule is andtherefore the rule invites creative accounting. As Hallerberg et al.(2010) and Wyplosz (2005) show, such a rule is difficult to monitorand does not have a strong record when it comes to containing theincrease of public debt. Among other countries, the United Kingdomuses a golden rule combined with a target for the overall debt level.

• Balanced-Budget-Rule: The probably the strongest possible fiscalrule, it requires that the budget be balanced each and every year.Should a deficit occur in one year (for example because of unforeseenevents), it has to be balanced by a surplus in the next years. ManyU.S. states and some regions in European countries have such a rule. InEurope, at national level only Estonia practices such a rule. This ruleis efficient in reducing the public debt, as shown by Poterba (1996).However, this type of rule has been criticised for not leaving any roomfor macroeconomic stabilisation and generating pro-cyclical effects.

• Cyclical Rule: A fiscal rule that requires a balanced budget over

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the business cycle. Governments have discretion to deviate from thebalanced budget target and use expansionary fiscal policy for examplefor macroeconomic stabilisation but then have to cut back the deficitin order to meet the target of the rule. This type of rule also has a goodempirical record, bringing the structural deficit close to zero (Boije andFischer (2007); Debrun et al. (2008)). Among the strong fiscal rulesin Europe, this is the most prominent type. It was first introducedin Sweden in the 1990s. Similar rules are in force in Switzerland andGermany.

Not all rules are adequate to substantially reduce the deficit bias. Ashas been pointed out earlier, most of the fiscal rules in Europe have a ratherlimited scope and touch only a fraction of the total budget. Also, many rulesthat are currently practiced are not easy to monitor because definitions ofspending heads covered by the rule are not sufficiently clear. As Hallerberget al. (2010) or Alesina and Perotti (1999) point out, the issue of transparencyis key for a successful rule. But in practice many rules are not sufficientlytransparent and invite creative accounting techniques.

For completeness, it should be mentioned that besides the governanceand the rules approach, there is also a third approach. It has mainly beenput forward by Wyplosz (2005) and Krogstrup and Wyplosz (2006) and isinspired by the analogy of monetary policy. In the same way independentcentral banks have been able to eradicate inflation, independent fiscal agen-cies would be able to eliminate the deficit bias. These fiscal agencies wouldbe composed of economic experts and make annual propositions on the gov-ernment revenues and spending. Executives and legislatures would thendecide the allocation of the funds. Fiscal agencies would be provided with aclear mandate to keep public finances at a sustainable level. Besides the factthat there is no economic theory on which levels of public indebtedness aresustainable, this proposition also comes with the problem that it deprivesdemocratic institutions, above all the legislature, of its most important right:To set and control the budget. Delegating that right to an expert body isdemocratically questionable, which is why these propositions have not beenwidely picked up in the research literature.

3 Stylised Facts on Fiscal Rules in Europe

As just discussed, fiscal rules vary largely and across multiple dimensions.They are therefore hard to compare across countries. In an effort to facilitatesuch cross country comparisons of fiscal rule strength, the European Commis-sion computes a Fiscal Rule Index (FRI)4 which takes many characteristics

4European Commission (2013)

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Figure 2: Evolution of the FRI for EU28 countries from 1990 to 2012.Source: European Commission

of fiscal rules into account and tries facilitate a cross-country comparison offiscal rules. The computation of this index will be discussed in section four.

The evolution of the FRI for the EU 27 countries is presented in Figure 2.From the graphs two first stylised facts become apparent: First, the strengthof fiscal rules has constantly increased in almost all EU countries - most ofthe increases happened in the early to mid 2000s while in a few countriesFRI value dropped slightly during the financial crisis. Secondly, it seems toincrease in leaps rather than gradually.

It is also informative to look at the geography of fiscal rules. Despitepopular expectation, there is no clear north/south divide. Also is the geo-graphical pattern variable over time, it is not possible to say that any easilyidentifiable group of countries would be taking the lead. A map of FRI val-ues in 2012 is presented in Figure 3. The map the the amplitude of FRIchange 1990-2012 (presented in Figure 4 shows a very similar picture. With-out few exceptions it can be said that countries that have the strongest FRIvalues have established these in the last 20 years. Again, there is no clearnorth-south distinction or another easily identifiable geography.

It is also quite informative to look at the correlations between FRI valuesand other important variables related to fiscal policy:

• Looking at the overall amount of debt, one finds a negative correlation

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Figure 3: FRI values for EU27 countries in quartiles in 2012. The brightestshade is top quartile, the darkest designates the lower quartile of FRI values.Source: Own calculations based on European Commission

with FRI. Since this is only a correlation, the interpretation is tricky:It could be that higher FRI values lead to lower debt levels – but itcould also be the inverse narrative, that countries with lower debt arefor some reason more able to implement stronger fiscal rules.

• There is no particular correlation between FRI values and growth. Thismight suggest that the argument used by many opponents of fiscal rulesthat they slow down growth prospects does not carry much weight, ifanything the effect of fiscal rules on growth seems to be neutral.

• Correlating FRI values with observed surpluses or the primary balance,one finds a strong positive correlation, indicating that higher FRI mightindeed lead to lower deficits. This is further supported by comparingaverage deficits before and after fiscal rule reform, finding that thelatter are almost always significantly lower than the former. This iseven more remarkable, as this includes the years of the financial crisis.

• In order to get some first ideas on what drives fiscal rule reform, one

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Figure 4: Amplitude of FRI change between 1990 and 2012 for EU27 coun-tries in quartiles. The brightest shade is top quartile, the darkest designatesthe lower quartile of FRI change. Source: Own calculations based on Euro-pean Commission

might look at the correlation between FRI values (or FRI change) andaverage surpluses before fiscal reform. One could expect a negativecorrelation, as countries with a higher deficit bias have more need forhigh FRI values. However, the correlation I find is positive, suggestingthat countries with a higher tendency to have low deficits are morelikely to implement fiscal rule reform.

Of course correlations have be considered with some caution, as theremight be other unobserved variables driving these results. Nevertheless, theexhibit an interesting picture. Fiscal rule reform is wide ranging and it doesnot follow a specific geographical pattern. Higher FRI values seem to behaving a positive effect on a variety of indicators describing public finances.The question what might drive fiscal rule reform is addressed with a morecomplete approach in the next two sections.

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4 Data and Method

4.1 Data

I gathered our data from different publicly available sources, most of theeconomic data is obtained from Eurostat. The political data is derived fromthe Manifesto Project which will described in closer detail below. A completelist of variables can be found in the Annex of this paper. Generally, the datacan be divided into three subgroups: economic, structural and political data.

Economic data, such as GDP, general and central government debt, im-ports and exports, unemployment, etc. are almost always obtained from Eu-rostat and were not subject to additional calculations. The FRI is computedby the European Commission based on country’s reposes to a questionnaire.This takes five criteria into account5:

1. Statutory/legal base of the rule

2. Room for setting or revising objectives

3. Nature of the body in charge of monitoring respect and enforcementof the rule

4. Enforcement mechanisms of the rule

5. Media visibility of the rule

Structural data, such as data population, constitutional features, dates,etc. are obtained from various sources described in the Annex and werenot subject to additional calculations. Also political data is obtained fromvarious sources, indices on the contract and delegation approach are ob-tained from Hallerberg et al. (2010), information on the governments andgovernment parties is obtained from the World Bank Database on PoliticalInstitutions6. Raw data on party polarisation is obtained from the Mani-festo Database7. The raw data assigns an ideology score to every party thatparticipated in elections based on word coding of election manifestos. Valuesrange between -100 (extreme left) to 100 (extreme right). This raw data wasused to compute the polarisation and ideology variables used in this dataset.The most important one is wpolar which is computed in the following way:First the arithmetic mean of the ideology of the parties in parliament is com-puted, secondly I take the weighted (by seat shares) average ideology from

5For each of these criteria a score is assigned depending on a countries performancein this area. These scores are aggregated and then normalised to be between 0 and 1.Since there is no accepted theory on weights, the European Commission uses a randomweights technique where 10000 sets of random weights are generated to calculate theindex in different ways. The random weights are drawn from a uniform distribution andnormalised to be between 0 and 1.

6Beck et al. (2001)7Volkens et al. (2013)

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the left and the right to this mean and then compute the absolute distancebetween these two gravity centers. Other polarisation variables are polar50,polar66 and polar75 which reflect absolute ideological distance between thecentre 50%, 66% and 75% of seats in parliament. I also use data on polari-sation in general politics and economic politics obtained through the CHESdatabase.

In total, my database comprises 120 variables (out of which only a frac-tion will be used in the regressions presented in this paper) with 648 datapoints. However, there is a problem with missing data for some countriesand years, which means that my baseline model is based on 339 data points.

4.2 Fixed-Effects OLS

Previous quantitative research on the political economy of reforms has mostlyused two approaches. The first consists in looking at all reforms, includingincremental ones, as measured by movement in relevant indices and regressthem over a set of explanatory variables. This strategy has been adopted byAlesina et al. (2006) and Galasso (2014) and many others. This is mostlydone by means of OLS regressions, typically with country and year fixedeffects to account for idiosyncratic variations. Galasso (2014) also uses tobitregressions for this purpose. The second approach consists in looking only atlarge reforms, excluding smaller, incremental reforms from the sample. Thisstrategy is employed e.g. by Duval and Elmeskov (2006). In this paper, Iuse both strategies in order to identify the drivers of fiscal rule reform.

Beck and Katz (1995) have written about the use of OLS regressions inpanel dataset and concluded that it is necessary to include a lagged depen-dent variable in order to achieve unbiassed results. A problem with FRI isthat it only changes values at the moment when a reform actually takes ef-fect. Being interested in the motivations of politicians to reform fiscal rules,I am however more interested in the political and economic context of thevoting of these reforms. Especially in fiscal rule reform the lag between voteand introduction can be substantial, much longer than it would be for otherkinds of reform, previously studied in the literature. However, lags betweenvote and introduction vary considerably. Given the inherent lag in FRI,I address this problem by accounting for the delay of introduction throughleads rather than lags in my dependent variable. This addresses also thepoint raised by Beck and Katz (1995) as it reflects the stationary nature ofthe data on fiscal rules. I did not use lead FRI values as dependent variable,as such an approach would be unable to account for the reforms that takeeffect without substantial lags.

In my baseline regression, variables of economic nature would be GDPlevel (GDP ), net lending as a fraction of GDP (netlendGDP ), general gov-ernment as a fraction of GDP (gendebtGDP ), a dummy variable taking thevalue 1 if economic growth slows down by than 5% from one year to another

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(crisis), the unemployment rate (unemploy), the degree of economic open-ness (openness)8 and debt service costs as a share of GDP (debtservGDP ).The structural variables are the average FRI value of all of the EU (avEU),whether a country is member of the eurozone (ez) or in the run-up phaseto join it (ezrunup), the degree of fiscal centralisation9, which acts as aproxy for the degree of federalism (fisccent), the general population (pop),the share of the population over 65 in the general population (pop65pop)as a measure of demographics and dummy variable taking the value one inthe year the country becomes a member of the EU (EU). Finally, politi-cal variables are a dummy variable for election years (elecyear), the aboveexplained measure of polarisation (wpolar), the number of parties in govern-ment (govpart) and a dummy taking the value 1 if the government is right ofcenter (absright).

Most of the analyses conducted in this paper rely on this model – orextended versions of it – in order to identify the main driver of fiscal reform.It is particularly interesting to study several sub-samples of the dataset.

4.3 Other regressions

The above described OLS regression comprises all reforms, including incre-mental ones. In addition, I look at large fiscal rule reforms two differentways. The first is a probit regression on a dummy variable called lgbreak,a variable that takes the value 1 if the extent of fiscal reform equals morethan a .5 leap in FRI value. This analysis is complemented with a tobitregression, using breaksize as dependent variable, a measure of the size offiscal rule reform. This second type includes again all reforms, not onlyparticularly large ones.

5 Results

5.1 Full Sample

The first question is which variables correlate with high FRI values – I ad-dress this question through the baseline regression. The results are presentedin Table 5.1. Apart from the lead dependent variable, the EU-average FRIvalue has a positive correlation with national FRI, the general governmentdebt is negatively correlated, as well as the number of parties in government,being a member of the Eurozone or being in the process of becoming one.Economic openness and debt service costs are positive associated with FRIvalues. Some of these observations are very interesting: First, the strongesteffect is the one of debt service costs, which is not surprising. A country that

8computed as the share of exports plus imports over GDP9computed as the share of central government expenditure in general government ex-

penditure

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encounters high debt service cost, is forced to reduce the expansion of its debtand ideally reduce the debt burden, which can be done through fiscal rules.Secondly, there is a strong effect of "keeping up with the neighbours", asmeasured through the EU-average. The negative correlation between largercoalitions and FRI value is not surprising, if there are more veto players,it is harder to get reforms enacted. What is however surprising, is thatthe eurozone and the run-up to the eurozone would ne negatively correlatedwith FRI values. Explaining this is not easy, a potential explanation couldbe that countries in the eurozone feel secure that they could rely on theirpartners solidarity and possibly bail-outs and hence do not feel obliged toresort to fiscal prudence as much as their non-eurozone neighbours. Finally,openness seems to matter, although the coefficient is quite small. This couldhave something to do with smaller fiscal multipliers in open economies, asidentified by Baum et al. (2012) and Baunsgaard et al. or it could have some-thing to do with open economies being more vulnerable to external shocks.There is also a negative correlation between general government debt andand FRI which can potentially explained in two ways: Either countries withlower debt levels find it easier to implement stronger fiscal rules, or it is thatstronger fiscal rules lead to lower general government debt. Given the im-portant effect of debt service costs, the second interpretation seems morelikely.

It is also quite interesting which variables are not significant. The dummyfor economic crises is not significant, nor are any of the political variables.This is puzzling as polarisation is clearly an important impediment to fis-cal reform. Also, findings of previous research, e.g. Galasso (2014), wouldsuggest that the partisanship of a government has an effect.

The analysis of the amplitude of fiscal reform, as presented in table 5.1,shows a slightly different picture. Here, political variables seem to be havinga stronger effect, as election years seem to be conducive to large fiscal reforms,whereas the size of the government coalition is confirmed as a brake to fiscalreform. The effect of election years is interesting in regard to the literature ona political budget cycle. This suggests that politicians believe the electorateis going to be overall favourable to fiscal discipline and that proposing fiscalreform in election years can be a vote winning strategy.

Let us subsequently turn to some subsamples which are particular inter-est. Generally, I will be running the same specification as in the baselineregression, unless otherwise stated.

5.2 Subsample: EU15

There are several reasons to look at EU15 countries separately. One reasonis that more data is available (e.g. including fiscal governance) and that thisdata contains much less missing values than for the whole sample which willlead to a cleaner result. For the EU15 sample, we run two regressions, first

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the baseline regression and then an extended version, controlling for variousother variables available for EU15 countries only. Subsequently, we turn tousing the baseline regression for non-EU15 countries. As the ex-communisteconomies in the non-EU15 sample exhibit much lower debt to GDP ratios,which is likely to have an effect on their fiscal constitutions, this is a veryinteresting subsample to study.

Table 5.2 presents comparison of the baseline model on the EU15 sampleand the remaining countries in the dataset. There is again a strong effect forthe average FRI of EU countries, the eurozone run-up dummy is negativeand significant, again the number of government parties lights up and thenegative correlation between FRI and general government is observed againtoo. An interesting difference is that debt service costs and economic open-ness are no longer significant. GDP levels are positively associated with FRIvalues but the coefficient is very small. In the non-EU15 sample, a differentpicture is presented. Here, debt service costs matter again as well as open-ness, suggesting that the overall results are partly driven by this subset. Also

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political variables seem to have a larger effect: Having a right-of-center gov-ernment is not conducive to strong fiscal rules and neither are strong levelsof political polarisation. In a more nuanced version of this regression (tableomitted), where the ideology of the government is broken down into right,center and left, significance levels for the political variables are lost. The signfor center governments is positive while the sign for left wing governments iseither just positive or just negative depending on the regression specification.However, not too much weight should be placed on these results due to lackof statistical significance.

In table 5.2, we look at an extended version of the baseline regression, onthe EU15 and the full sample. For EU15 countries, more data is available,which allows to test for additional variables. Hallerberg et al. (2010) havecomputed an index (delegidx and contracidx) whether a country follows thedelegation or contract approach to fiscal governance. We use this index toidentify whether this has any effect on the likelihood of a country to adopt astronger fiscal rule. In addition, we also test for central bank independence

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(indcbank), using an index developed by Dincer and Eichengreen (2013) anda dummy variable (maj) taking the value 1 if a country has a majoritarianelectoral mode. By this we test whether the findings of Persson and Tabellini(2005) – who find that majoritarian countries typically exhibit lower deficits– can be transposed to fiscal rules.

For the EU15 sample, the EU average seems to matter, as well as netlending and openness. There is also a seemingly huge negative effect ofcentral bank independence. This has however to be taken very cautiously.Given that most EU15 members have adopted the Euro, there is not muchvariation in the data. It is quite likely, that this result is driven by countries– notably the United Kingdom and Sweden – that have high FRI valuesbut relatively low degrees of central bank independence. In the full sample,which is more meaningful for central bank independence as it includes manynon-eurozone countries in central and eastern Europe, there is no longer asignificant effect. If central bank independence is omitted from the regressionrun EU15, most effects persist, except for unemployment and debt servicecosts getting relevant again (table omitted).

While the EU15 sample seems to be confirming the general results, the

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additional variables do not seem to be having a significant effect. In thecase of the indices for the contract and delegation approach this might havesomething to do with bad data: These indices are only available for selectedyears and hence meaningful variation might not have been observed.

5.3 Subsample: North vs. South

In the recent debates some commentators have highlighted different cul-tures and traditions of fiscal policymaking in northern and southern Europe.Hence, I examined this sub sample to identify potential differences. Thesample was split up in northern or southern countries based on whethera country’s geographical mid-point was north or south of the EU28’s mid-point.

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As table 5.3 shows, there are in fact some interesting differences andsimilarities between northern and southern European countries. AverageEU FRI level is significant for both samples and the effect has a similarmagnitude. We also encounter the negative effect of being or becoming aeurozone member in both samples, with ez in the northern European sampleand ezrunup in the southern sample. But the differences might be moreinteresting than the similarities: For northern European countries, thereseems to be a larger effect of economic hardship, as evidences by the effectsof crises and unemployment. Finally, we obtain a negative effect of thedemographics variable, which is puzzling. This effect is however not robustto using other demographic variables, such as fertility rates or overall changesin population rates, in the same regression context. In southern Europeancountries, the effect of debt service costs is significant and seems to be themost important driver of fiscal reform.

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5.4 Before and After the Financial Crisis

The last sub-sample that is of particular interest is whether the great finan-cial crisis and the European debt crisis in its aftermath have changed thedynamics of fiscal rule reform. In order to study this, the sample is dividedin the time up to 2008 and the years after10. The results are presented intable 5.4.

For the years before the crisis, we encounter a similar picture than inprevious regressions. Significant are debt service costs, average EU FRI,ezrunup and GDP levels. Interestingly, all of this is lost for the years after2008, only GDP levels and the lagged dependent variable remain significant.This indicates that indeed the dynamic of fiscal rule reform changes. Gov-ernments no longer seem to respond to immediate pressures such as debtservice costs or keep up with the governance levels of their European part-

10using 2007 as cut-off year produces almost identical results

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ners. Fiscal rule reform is now driven by another unobserved variable. Verylikely, this is the reform of fiscal institutions at the European level, with itsmanifold implications for national fiscal frameworks.

5.5 Results: Summary

The picture presented by the regression results is fairly consistent. Generally,governments seem to be driven by two effects, first high debt service costsand secondly, to keep up with the average governance standards of theirEuropean partners. To a lesser degree, it seems that richer countries are morelikely to have strong fiscal rules as well as open economies. Interestingly,many politicians seem to be undertaking fiscal reforms in election years,suggesting that this will be a vote winning strategy. Important detrimentsto fiscal reform are large government coalitions, probably because the largenumber of veto players makes it hard to find a consensus on the content offiscal reform.

Dividing the sample into sub-samples shows interesting insights. Espe-cially between the EU15 countries and the remainders of the EU countries,a different dynamic is in place. Eastern European countries seem to be moresusceptible to political variables, as polarisation and right of center govern-ments are important obstacles to fiscal reform. This difference between EU15and non-EU15 countries could arise from a different debt dynamic. As debtlevels in eastern European countries are typically lower, introducing strongerfiscal rules is more a political choice than an public debt management im-perative, as it is in many EU15 countries with high debt levels and hencehigh debt service costs.

The comparison between northern and southern European countries isalso quite insightful, as it shows a propensity of northern European countriesto react to different measures of economic crisis (growth rates, unemploy-ment, etc.) through stronger fiscal rules, an effect that cannot be found forsouthern european economies, where debt service costs and average EU fiscalrule levels remain the most important drivers (and those are very relevantin northern European countries too).

Finally, the results presented here contain a few puzzling element. First,the apparently negative influence of the being or becoming a eurozone mem-ber. For becoming a eurozone member, one could advance the explanationthat countries are unwilling to implement a reform with potentially impor-tant macroeconomic consequences while their potential eurozone accessionis based on the stability of their economy. This explanation however doesnot work for the countries which already are members of the eurozone. Aless benevolent explanation would be that becoming a member of the euro-zone lowers debt service costs and hence removes one of the most importantdrivers of the reform.

Another puzzling element is the general insignificance of political po-

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larisation. Except for eastern European countries, this variable is largelyinsignificant. This is surprising, as the ability to form a consensus across awide range of parties is essential to obtaining the large majorities required forconstitutional reform. Possibly this might be due to the difficulties involvedin measuring political polarisation, hence the next section of this paper willaddress the question of robustness of polarisation results.

6 Robustness

6.1 Robustness of Polarisation Variable

One of the trickiest variables in the dataset is the measurement of polarisa-tion and ideology. Obviously, these elements are hard to quantify but theway of measuring them might matter to a large extent. Also, the Mani-festo Database which I have used to construct our data does not measurepolarisation or ideology when it comes to economic and financial affairs butpolarisation in general. I have chosen to use the manifesto database anyway,because I assume a strong degree of correlation between general polarisationand ideology and economic polarisation and ideology, hence it can be usedas a valid proxy. One advantage of the Manifesto Database is that is basedon word analysis rather than expert survey which makes it more objective.Also, it covers a wider range of years and countries than any other databaseI am aware of. However, in order to address potential robustness issues, wecompare it to the data from the Chapel Hill Expert Survey (CHES) whichfeatures data on both general ideology and ideology in economic and financialaffairs and the polarisation variable in World Bank Political Database.

Table 1: Correlations between the different measures of polarisation. wpolar,polar50, polar66 and polar75 are based on the Manifesto Database, whilestnpol and stnecon are based on the CHES Database. polariz is taken fromthe World Bank Political Database.

stnpol stnecon polar50 polar66 polar75 wpolar polariz

stnpol 1 0.37 -0.20 -0.09 -0.08 -0.01 -0.30stnecon 0.37 1 0.32 0.30 0.21 0.35 0.23polar50 -0.20 0.32 1 0.61 0.62 0.65 0.66polar66 -0.10 0.30 0.61 1 0.95 0.97 0.44polar75 0.09 0.21 0.62 0.95 1 0.93 0.47wpolar -0.01 0.35 0.65 0.97 0.93 1 0.52polariz -0.30 0.23 0.66 0.44 0.47 0.52 1

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The CHES database covers 14 Western European countries. Expert sur-veys were conducted in 1999, 2002, 2006, 2010 – which is another disadvan-tage compared with the Manifesto Database, which is based on manifestoanalysis, and hence values change in election years which is likely to be moremeaningful than changes in arbitrary years. The CHES database makes anaverage ideology score per party available for the given years, from which Iused the averages to account for the overall ideological position of a coun-try and the standard deviation as a proxy for polarisation, both for generalpolitics and for economic and financial affairs.

Using the CHES data in regressions does not alter the results substan-tially. stnecon remains non-significant throughout, stnpol is significant onlyfor the general sample and EU15 countries. Generally, the fit of the regres-sions is much less good due to the lower amount of data and variation. Forsimilar sample sizes, the significance levels and signs for the other variablesin the dataset are comparable.

The World Bank Data captures the degree of polarisation between theexecutive party and the four principle parties of the legislature. However,the underlying ideological characterisation is rather sketchy, since parties arequalified as either right (value = 1), left (value = 3) and centrist (value =2). Regression analysis with the World Bank Dataset is not possible due tolack of variation over time.

Using different data on polarisation does not produce substantially al-tered results. The findings on polarisation based on wpolar remain thusvalid. In an additional exercise, I created a variable called devwpolar, thatmeasures the deviation between wpolar levels in a given year and averagewpolar levels. This allows to check whether not the degree of polarisationmatters but the fact that polarisation is more or less than average. Thisvariable is significant only for eastern European countries, hinting that lowerthan average polarisation levels are conducive to fiscal reform. For all othersamples it remains significant.

The lack of explanatory potential of polarisation remains a puzzle thancannot be resolved within this paper. It is going to be subject of the nextchapter, which will examine the role of political polarisation in selected casestudies and forward some explanation why this variable does not seem quan-titatively important although it would be expected to be so.

6.2 Other Robustness Checks

The results presented in the analysis do not vary substantially dependingof the precise choice of variables used. This is relevant for variables wherea degree of choice is possible, such as growth variables. The regressionspresented here have been estimated with the growth rate, the output gapand a recession dummy instead of crisis. The results confirm the findingsof the regressions presented.

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Similarly, other choices are possible for the demography variable. Insteadof the share of people over 65 in the general population, the fertility rate andthe overall change in population have been studied. Again, the results weremostly similar. A general problem with any kind of demography variableis that changes from one year to another are tiny and the presence of ademographic problem might not be picked up by such data. It is perfectlypossible that demography is an important driver of fiscal reform althoughthis is not reflected in this data.

Generally, the use of many indices for political variables is problematic.Almost never are these indices computed on an annual basis. This is problem-atic for indices such as central bank independence, contract and delegationapproach indices and the degree of federalism. Using fisccent as a proxyfor the degree of federalism was the only workable solution, as indices of thedegree of federalism typically exhibit no changes over time and hence cannotbe included in the regression analysis. There is some degree of variation forcentral bank independence and fiscal governance indices but changes in val-ues might not always occur in the year when the actual changes were made,as these indices are computed only every few years.

Conclusion

This paper uncovers the most important determinants of strong fiscal rules.I analyse a series of subsamples and different explanatory variables in orderto identify the most important determinants of fiscal rules. I do so mostlythrough OLS analysis and – to a more limited extent – tobit analysis. I usethe OLS regressions to explain changes in FRI value while the tobit analysisis specifically used to explain large reform projects.

Generally, it appears that fiscal rules are improved as a consequent topressure from debt service costs and of the willingness to keep up with thestandards of other European partners. Other economic variables such asGDP levels and economic openness matter to a lesser degree.

Political variables have less influence, the strongest effect is the reformof fiscal institution in election years, potentially as a vote winning strategy.Political polarisation does not have a large effect, only for eastern Europeancountries it seems to matter. Also, having a right-wing government is notconducive to fiscal reform.

It would be interesting to study the subject of this paper in a larger in-ternational context. This would also allow to study the influence of differentconstitutional features, such as electoral mode, regime type, etc. which donot vary largely within the European Union. Unfortunately, such a study ishowever difficult given the lack of data on the quality and strength of fiscalrules on an international scale.

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