THE IMPACT OF FISCAL

RULES ON PUBLIC FINANCES

IN THE EURO AREA

WIM MARNEFFE*, BAS VAN AARLE*,

WOUTER VAN DER WIELEN* AND

LODE VEREECK*

Introduction

Due to the 2008–09 financial crisis and ensuing eco-nomic downturn, budgetary problems are on the pol-icymakers’ agenda once again. Fiscal deficits in-curred as a result of the financial crisis and econom-ic downturn have caused public debt to rise steeplyonce again. Moreover, the public debt of some EUcountries was already at a high level before the cri-sis. At a high level of public debt, public finances be-come susceptible to adverse interest rate and eco-nomic growth fluctuations. If interest rates increase,advantageous government programs may be post-poned, a debt trap may arise, and crowding out mayreduce private investments. Interest rates may in-crease due to the growing risk aversion and the emer-gence of risk premiums on sovereign debt. Greece,Ireland and Portugal, which have been the hardesthit by the European debt crisis, have received sup-port from the IMF, and the new EU and the euroarea’s Financial Stabilization Mechanism and Finan-cial Stability Facility.

The fiscal turmoil has also pointed out again theneed for an adequate framework of fiscal manage-ment and fiscal rules. Fiscal rules and guidelines,whether quantitative in nature or of a more qualita-tive character, indicate the way public financesshould be managed and the direction in which poli-cymakers should aim public finances to evolve. Fiscalrules seek to provide a solution to the deficit biasproblem that is caused by politicians’ short-sighted-

ness and the common pool problem. We divide fiscalrules into two categories:(i) fiscal rules that primarily aim at restricting gov-

ernment spending, budgetary deficits and gov-ernment debt in order to safeguard fiscal sustain-ability. The fiscal rules inspired by (neo)classicalprinciples fall into this category.

(ii) Fiscal rules that primarily aim at stabilizingmacroeconomic fluctuations. These rules areguided by short-run (new) Keynesian principlesof fiscal management.

This paper reviews the principles underlying fiscalrules and applies them to the current EuropeanUnion. In the European Union, the supranationalStability and Growth Pact (SGP) should provide thenecessary guidance to limit governmental borrowingby member states. In addition to the SGP, Europeancountries are implementing various other fiscal rulesthat bind central, regional and local governments.We provide empirical estimates of the effect of fiscalrules on fiscal variables in the euro area.

Fiscal rules and sustainability of public finance:classical principles

Neoclassical economics assumes that no policyimpulses are necessary to stabilize production andemployment – as these would represent efficientmarket outcomes – and proposes that policymakerspursue best a balanced budget strategy. Governmentexpenditures are seen as consumptive and to befinanced by current tax revenues. Financing suchconsumptive expenditures with public debt wouldcrowd out private investments due to increasing in-terest rates. Although the balanced budget rule isstill widely used, it has to be taken into account thata balanced budget does not necessarily have a neu-tral impact on the economy, as shown by the bal-anced budget multiplier theorem. In addition, a bud-get balance does not only result from discretionarypolicy, but is also affected by automatic stabilizersand expectations. Revenues would also have to betailored to needs; a discretionary (possibly counter-cyclical) revenue policy aimed at avoiding any bud-get deficit or surplus is, however, not self-evident. To

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* Hasselt University, Diepenbeek, Belgium.

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overcome such difficulties with balanced budgetrules, the golden rule is a preferable alternative. Neo-classical economists argue that fiscal deficits are per-mitted, if destined to finance productive public in-vestments, because these investments would recovertheir costs in the long run. As a result, a stabilizingpolicy is possible by means of productive invest-ments while a country’s (net) public debt would re-main constant in the long term.

Fiscal rules based on (neo)classical principles, con-centrate on securing solvency of the government:focusing on the intertemporal budget constraint,they seek to assess if governments will be able tobear the future burden of public debt. The budget isconsidered to be intertemporally sustainable if thecurrent public debt equals the net present value ofexpected/ planned future primary balances. With theintertemporal budget constraint, a country’s fiscalgap can also be determined. The fiscal gap reflectsthe net present value of future government expendi-tures, including servicing public debt, and future rev-enues. In fact, it is a measure of the additional bur-den that will need to be imposed on future genera-tions to satisfy the intertemporal budget constraint.

The (public) debt trap has scourged public financesin many European countries in the past. Thus avoid-ing a recurrence of this experience is a primordialobjective of current fiscal policy. The debt trap canbe defined as a vicious circle in which an initial bud-get deficit has to be funded by public debt, which inturn increases a country’s interest burden and conse-quently its deficit, and thus further increases publicdebt. The debt trap can be stopped using three para-meters: raising the primary budget balance as a per-centage of GDP, lowering the average rate of inter-est due on public debt and increasing the growth rateof GDP.

Fiscal rules and macroeconomic stabilization: newKeynesian principles

In the 1930s the Great Depression brought about ashift in economic thought. As Keynesianism wonground, cyclical expenses and revenues that act asautomatic stabilizers were considered desirable intimes of recession when a countercyclical policy ispreferred to a balanced budget. This is necessary asmarket mechanisms alone are assumed not to be suf-ficiently strong to restore full employment. More-over, budgetary stabilization policy consists not only

of automatic stabilizers, like progressive tax ratesand unemployment benefits, but can also be comple-mented by discretionary interventions that can be(partly) guided by considerations of countercyclicalmacroeconomic policy management.

Despite the potential benefits of budgetary stabiliza-tion policy, Keynesian policy principles displayedsome shortcomings in the past. For example, duringthe 1980s policymakers in many European countriesunderestimated future debt problems. Moreover,asymmetric applications were often observed. Dur-ing economic downturns a stabilization policy wasapplied by raising expenditures and cutting taxes. Inbooms the policy would, however, require cuttingexpenditures and raising taxes. Politically, this wasvery difficult to implement. Furthermore, downturnswere often misused by politicians to fund more ex-penditures than necessary. The resulting deficit biasimplies that debt repayment issues also begin to mat-ter as a country is eventually expected to repay itsdebt. Clearly, there is a limit to both the stabilizationpossibilities and the lending capacity.

The distinction between cyclical and structural bal-ance can be to used to integrate the two fundamen-tal approaches outlined above. The structural bal-ance can be used to assess the (neo)classical per-spective with its emphasis on long-run sustainabilityissues. The cyclical balance can be used to assess theKeynesian aspect of short-run anti-cyclical stabiliza-tion. Taken together, this implies that a structurallybalanced budget should be attained in the long run,and a countercyclical policy is prescribed for theshort run. A country can incur deficits by increasingexpenditures during an economic downturn, as longas those deficits do not surpass the surpluses built upduring the preceding economic boom. Consequently,public debt will remain constant in the long run.However, this rule is not precluded from serious lim-itations. As business cycles are not symmetrical, nei-ther in length nor size, over- and undercompensationcan arise. What is more, public choice theory andpolitical economy theory emphasize that there willbe insufficient downward flexibility of expendituresduring booms due to political factors.

Fiscal rules in the EU: the Stability and GrowthPact and beyond

The first binding set of supranational fiscal rules wasintroduced by the Treaty of Maastricht in 1992 on

the Economic and Monetary Union of the EuropeanUnion (EMU). Admission to the third and finalphase implied the introduction of a common curren-cy unit. To be admitted to the euro area applicantshad to meet convergence criteria with regard toprice stability, exchange rate stability, the long-termrate of interest and fiscal policy. The last criterionrequired the absence of excessive budget deficits.Whether a deficit is considered excessive or not isdefined by article 104 C §2 and the accompanyingProtocol on the Excessive Deficit Procedure: the an-nual budget deficit should not be higher than 3 per-cent of GDP, unless it has been on a decreasing pathor is of an exceptional and temporary nature. Also,total public debt should not be larger than 60 per-cent of GDP, unless it has been on a decreasing pathand the benchmark is being approached at a satis-factory rate.

The fiscal criteria also apply once countries havejoined the euro area since fiscal discipline is crucialfor the well-functioning of a common currency. Theunified money and capital markets pose the threatthat increasing deficits in one or more countriescould endanger the stability of the euro zone as awhole. High deficits in one member state could in-crease interest rates for all member states. Further-more, the European Central Bank could be put un-der pressure to mitigate the increase in the rate ofinterest by relaxing its monetary policy or be pres-sured to use monetary finance (including buying upgovernment debt) to prop up member states in fi-nancial distress. This would be inconsistent with itsprice stability policy and damage the credibility ofthe euro area.

In response to a number of shortcomings that hadbecame apparent and to meet broad criticism, thepact was revised in 2005. Firstly, the changes led to amore contextual consideration of member states’ cir-cumstances. Henceforth, member countries with apublic debt less than 60 percent of GDP could pur-sue a structural deficit of 1 percent of GDP in themedium term, while countries with a higher debtwere expected to pursue a balanced budget or smallsurplus. Every year countries were required to movea half percent of GDP towards their medium-termobjective.When economic growth is higher than pro-jected this would be more than a half percent to al-low reduced efforts during an economic downturn.Secondly, since the revision of the pact not only thedecline of economic growth is taken into account butalso the duration of the economic downturn. Thirdly,

the time span in which excessive deficits need to becorrected was broadened from one to two years.Various other adaptations of the pact were proposedbut not (fully) implemented (see Fischer et al. 2006for an extensive overview). Some included the sim-ple proposal of well-known approaches, such as thegolden rule or the adoption of a cyclically adjustedbudget balance rule. Others present a more complexadjustment of the pact, such as a complex system oftradable deficit permits.

As any fiscal rule, the Stability and Growth Pact isalso plagued by shortcomings. The numerical valuesof its benchmarks remain arbitrary and are possiblycounterproductive from the perspective of counter-cyclical fiscal stabilization policy. Furthermore, sub-stantial doubt remains whether the pact is able todeliver fiscal sustainability. The current fiscal climatehas only increased this doubt as fiscal prudenceappears to be slipping. One of the main targets ofcriticism concerns the pact’s ineffective penalties. Asecond aspect of the criticism is the increased flexi-bility of the revised pact. As a considerable series offactors need to be taken into consideration to judgewhether a deficit is excessive, loopholes exist andjudgment is complicated. As a result, the fiscal rule isassessed to be less transparent and simple. Thus, theincreased flexibility also has considerable disadvan-tages as argued by Buti (2006). With regard to publicdebt, finally, the pact is clearly a step backwards incomparison to the Treaty of Maastricht as, in addi-tion to the limited contextual approach, the pactdoes not provide a clear penalty for infringement ofthe debt benchmark.

Academic research and practical experience provides anumber of important principles that should govern fis-cal rules. Kopits and Symansky (1998) formulated eightbasic properties for an “ideal” fiscal rule. A fiscal rulemust be well-defined, transparent, simple, flexible, ade-quate, enforceable, consistent and efficient. However,as public budgeting and finance is an economic matter,some specific economic requirements are also neces-sary to enhance a effectiveness of fiscal rules.

Based on the above considerations we deduce thefollowing recommendations:

(i) A relative measure to preclude fiscal drag isadvisable. A relative measure will also improvea fiscal rule’s effectiveness by facilitating com-parison over time as well as between countries.

(ii) Comparability is enhanced when there is a cor-

rection for inflation.

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(iii) A budgetary constraint should not only refer to

the balance to avoid potential adverse effectson the underlying components of the budgetbalance (e.g., undesirable tax increases to com-pensate for structural problems on the expendi-ture side of the balance). Therefore, govern-ment expenditures and revenues also need tobe included in the design of fiscal discipline.

(iv) Effectiveness will also be enhanced when therule supports a medium term (instead of a shortterm) approach. That way, policymakers arecompelled to pursue a more sustainable fiscalpolicy since the future consequences of shortterm measures must be taken into considera-tion. Possible manipulations of the timing ofexpenses and revenues in order to change thestock and/or composition of government debtover time are discouraged. Moreover, fiscal pol-icy becomes more predictable which enhancespublic confidence.

(v) The standard budget balance is insufficient toassess the stance of fiscal policy: taking intoconsideration cyclical and structural effectsseparately is necessary.

Relating to these economic requirements, theStability and Growth Pact’s effectiveness remainsdoubtful. The pact contains relative measures for thebudget deficit and the public debt. Furthermore, it isa more medium-term oriented approach and incor-porates a structural measure. However, nothing hasbeen laid down with respect to the cyclical portion ofthe budget balance. Moreover, the pact does not payattention to the underlying parts of the budget bal-ance, nor does it take into consideration the rate ofinflation. The necessity of reform is further empha-sized when the pact is assessed according to the fun-damental requirements of an ideal fiscal rule. Al-though its simplicity has been widely acknowledged,the enforceability of the pact seemed to be the prin-cipal problem both before and after the 2005 reform.This is in accordance with the above-mentioned lackof sufficient and effective penalties.

As a result, member states of the European Unionare employing and prolonging the application ofdomestic alternative rules. One may argue that this issimply to comply with the fiscal rules of the pact.Alternatively, it could be considered that the domes-tic rules are a means to achieve a more prudent fis-cal policy given the shortcomings of the pact. Thepresence and nature of the complementary domesticfiscal rules is illustrated by data in Table 1. The data

are based on the results of two rounds of surveysconducted by the Directorate-General for Economicand Financial Affairs (DG ECFIN) of the EuropeanCommission in 2006 and 2008 in order to map outfiscal governance in EU member states. These sur-veys asked for information directly from the EUmember states on the character of the fiscal rules intheir country and their coverage, their statutorybase, monitoring and enforcement mechanisms, aswell as experience with respect to the rules.1

Some member states apply more stringent rules thanthe Stability and Growth Pact. For example, Estoniaand Portugal apply a balanced budget rule, the UKand Germany use Golden Rules, Denmark targetsstrict structural surpluses, and Spain expects its gen-eral government to reach a budget surplus of 1 per-cent of GDP over the business cycle. Only threecountries had not introduced their own fiscal rules

Table 1

Domestic fiscal policy rules in effect since 2008,EU-27

EU memberstate

Budgetbalance

rule

Expendi-ture rule

Revenuerule

Debtrule

Austria 1 Belgium 3 1 Bulgaria 1 1 CyprusCzechRepublic

1

Germany 3 1 1 Denmark 1 1 1 Estonia 1 1 Greece Spain 2 3 Finland 2 1 1 France 1 2 1 1 Hungary 1 1 Ireland 1 2 Italy 2 2 Lithuania 1 1 1 1 Luxembourg 1 1 1 Latvia 1 1 MaltaNetherlands 1 1 Poland 1 Portugal 2 2 Romania 1 1 Sweden 2 1Slovenia 2 Slovakia 1 1 United King-dom

1 1

Total 26 17 6 19

Source: Based on own calculations using data from DGfor Economic and Financial Affairs of the European Commission.

1 The original data are made publicly available at http://ec.europa.eu/economy_finance/db_indicators/fiscal_governance/documents/1-db_fiscal_rules_en.xls.

when the survey was last conducted in 2008 (i.e.,Cyprus, Greece and Malta).

The Stability and Growth Pact has established supra-national directives with regard to fiscal policy. Yet,member countries maintain a lot of freedom inachieving them. The data show that this eventuallyleads to a broad set of different domestic rules. Furth-ermore, those numerous rules do not all prove to beeffective according to the European Commission(2009). In addition, most lack independent monitor-ing and have poor enforcement mechanisms in caseof non-compliance. It is also clear that uniformity ismissing with regard to fiscal policy rules in the EU.Policymakers are facing a dilemma. On the one hand,the pact seems to be insufficient to achieve its eco-nomic objectives, establish uniformity and couldseem rather redundant considering the numerous(more stringent) domestic rules. On the other hand, alarge portion of those domestic rules is not effectiveenough to devolve all fiscal power on member states.

A first possible solution to this dilemma would be touse the current structure of supranational rules, com-plemented by domestic rules to reach the most desir-able fiscal policy. For instance, it could be made theresponsibility of the member states to regulate therevenues and expenditures underlying the budget bal-ance. However, as mentioned above, there exist largedifferences in the effectiveness of the currently imple-mented domestic fiscal rules. Therefore, it would benecessary to co-ordinate the national responsibilities.For example, supranational policymakers could usethe above-mentioned requirements as guidelines forthe rules implemented by member states.

A second solution would be toprofoundly reform the pact onceagain. As mentioned above therehave been a large number of pro-posals to revamp the pact. There-fore, it would be difficult to agreeupon the most appropriate reformthat would remedy the pact’s short-comings. For example, there areboth advocates for and opponentsof more supervision of the na-tional fiscal policy by independenteconomic committees or institu-tions. Moreover, an unanimous de-cision of the member states wouldbe necessary as a reform requiresthe alteration of the regulation of

the Council of the European Union. Consequently,this solution seems fairly unlikely to occur, although itwould enhance European uniformity and could makedomestic fiscal rules superfluous.

Effects of fiscal rules on the fiscal stance in theeuro area: empirical evidence

To capture the influence of the institutional featuresthat foster the effective implementation of fiscal rules,DG ECFIN has constructed indexes of strength of fis-cal rules, using information on (i) the statutory baseof the rule, (ii) the body in charge of monitoringcompliance with the rule, (iii) the body in charge ofenforcement of the rule, and (iv) the enforcement me-chanisms relating to the rule. Based on the strengthindex for each rule, a comprehensive time-varyingFiscal Rule Index (FRI) for each member state wasconstructed. This FRI is calculated by summing upall fiscal rule strength indices in force in the respec-tive member state, weighted by the coverage of gen-eral government finances using the respective rule(to take into account that, e.g., a fiscal rule applica-ble to a local or regional government may not be rel-evant at a national level). Figure 1 displays this FiscalRule Index for the euro area countries.

Countries in the euro area continue to display con-siderable variation in the characteristics of their fis-cal rules, possibly more than one would expect in acommon currency area. Over time, an increase in theeuro area average fiscal rule index is observed, sug-gesting an increasing importance of the fiscal rules inthe euro area fiscal management.

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0

0.5

1

1.5

2

2.5

3

1 2 3 4 5

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Austria Belgium Cyprus Germany Euro AreaGreece Spain Finland France IrelandItaly Luxembourg Malta Netherlands PortugalSlovenia Slovakia

Source: European Commission.

FISCAL RULES INDEXEuro Area 1990–2008

Figure 1

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To analyse the effects of fiscal rules on the fiscalstance, we estimated panel regressions for the 16 euroarea countries for the period 1995–2008. We estimatethe impact of the fiscal rule index on (1) the fiscal bal-ance, (2) the primary fiscal balance, (3) governmentspending, (4) government revenue, (5) the structuralprimary balance, (6) the cyclical fiscal balance, (7) thefiscal impulse and (8) the primary fiscal balance gap.To do so, we add the Fiscal Rule Index to otherwisefairly standard estimations of these eight budgetaryreaction functions that include also the lagged depen-dent variable, the output gap and the debt level. Thisapproach makes it also possible to consider theessence of both the classical and the Keynesianaspects of fiscal policy rules as outlined in the first twosections of this article. The presence of the output gapreflects the importance of cyclical factors in fiscal vari-ables, the presence of the debt level the impact of fis-cal sustainability considerations.We include a constantand/or trend if they improve the estimation resultsfurther. Country-specific fixed or random effects wereincluded in some cases but are not reported.

In most cases, regression results confirm the exist-ing literature: the effects of the output gap andlagged debt on the fiscal variables are similar tothose found in other empirical estimations of fiscalbalance equations (see, e.g., Claeys 2008, andBallabriga and Martinez-Mongay 2003). Anincrease in debt contributes to a lower total balance(column 1), reflecting the interest burden, but alsoto a higher primary balance, reflecting a stabilizingmechanism, as a high debt level increases the (per-ceived) need to improve the primary fiscal balance.The Fiscal Rules Index has in most cases a signifi-cant positive effect on the fiscal balance (both onthe total fiscal balance and the primary fiscal bal-ance (column 2). This suggests that fiscal rules havehad a deficit reducing effect and are in that senseimportant for the workings of fiscal policy in theeuro area: stronger fiscal rules in a country andover time contribute to a lower deficit. Fiscal rulestend to have a negative effect on government spend-ing (column 3), while no significant effect on gov-ernment revenues (column 4).

Table 2 Panel estimation of the effects on fiscal rules on fiscal stance, euro area-16 countries

Dependent

variable

(1) Fiscal

balancea)

(2) Primary balanceb)

(3) Total

governmentspendingc)

(4) Total

governmentrevenued)

(5) Structuralprimarybalancee)

(6) Cyclical

fiscalbalancef)

(7) Fiscal

impulseg)

(8) Primary

fiscal balancegaph)

Constant 3.00*** (0.80)

8.10*** (1.81)

– 0.32 (0.28)

0.16**

(0.08)

2.67 (0.64)

Laggeddependentvariable

0.64*** (0.05)

0.71*** (0.05)

0.93*** (0.02)

0.79*** (0.05)

–0.76*** (0.05)

0.39 (0.05)

– 0.15** (0.07)

0.46*** (0.08)

Output gapi) 0.08 (0.06)

0.07 (0.06)

0.05 (0.06)

0.06 (0.05)

–0.12* (0.06)

0.26*** (0.02)

0.12**

(0.06)

0.22 (0.13)

Lagged debtj) – 0.008** (0.003)

0.01** (0.005)

0.002 (0.004)

0.02* (0.01)

0.01** (0.003)

– 0.001 (0.001)

0.001 (0.002)

– 0.06** (0.03)

Fiscal Rules Indexk)

0.41*** (0.13)

0.32** (0.15)

– 0.24* (0.12)

– 0.32 (0.22)

0.28** (0.13)

– 0.005 (0.03)

– 0.001 (0.12)

– 0.98** (0.42)

Time trend – 0.0001 (0.0001)

Adjusted R2 0.65 0.59 0.95 0.97 0.68 0.74 0.13 0.54

S.E. regression 1.70 1.67 1.36 0.99 1.57 0.44 1.62 2.62

Log likelihood – 384.38 – 366.17 – 332.7950 – 262.34 – 365.83 – 122.24 – 389.35 – 281.66

Durbin Watson 1.50 1.63 1.87 1.94 2.03 1.66 1.99 1.71

Mean dep.variable

– 1.42 1.68 44.84 43.39 1.32 0.20 0.12 – 2.09

No. Obs. 198 191 198 198 197 206 206 153

***: significant at a 1% level. **: significant at a 5% level. *: significant at the 10% level.a) Net lending /Net borrowing (-) as a % of GDP under the Excessive Deficit Procedure, source Eurostat. – b) Primaryfiscal balance as a % of GDP, source Eurostat. – c) Total general government expenditure as a % of GDP, sourceEurostat. – d) Total general government revenue as a % of GDP, source Eurostat. – e) Structural primary fiscalbalance as a % of GDP, source: European Commission data. – f) Source: European Commission data. – g) Fiscalimpuls = -� (structural primary balance/GDP). – h) Primary fiscal balance gap = primary fiscal balance – debt toGDP* (interest rate – growth rate). – i) Source: European Commission data. – j) General government consolidatedgross debt as a % of GDP, source Eurostat. – k) Fiscal Rules Index compiled by the EU Commission.

In column 5, the reaction function for the structuralprimary fiscal balance is estimated, a measure that isclosely linked to the fiscal stance and to the long-runfiscal sustainability. It shows that a stronger FiscalRule Index improves the structural primary fiscalbalance, a finding that confirms the results of theEuropean Commission (2010) for the sample of allEU countries.2 A higher debt level also increases thestructural primary fiscal balance indicating – as indi-cated in column (2) – a stabilizing effect from highdebt on the primary structural deficit. An increase inthe output gap reduces the structural primary fiscalbalance suggesting some pro-cyclicality in this dis-cretionary part of the fiscal balance. In the literature,some studies find pro-cyclicality in the structural pri-mary balance, while in others evidence for the moredesirable property of anti-cyclicality is found. In theestimation of the cyclical fiscal balance, column (6),the output gap plays an import role, reflecting therole of automatic stabilizers; the Fiscal Rule Indexdoes not seem to have an effect on the cyclical deficit.Column (7) displays the estima-tion results for the fiscal rule forthe fiscal impulse. An increase inthe output gap increases the fiscalimpulse, implying again a pro-cy-clical bias in discretionary fiscalpolicy. A higher fiscal rule indexmay somewhat reduce the fiscalimpulse even if the coefficient isnot estimated precisely. Finally, pri-mary fiscal balance gaps, column(8), are reduced by a higher FiscalRule Index.

To estimate the effects of the fiscalrules on the fiscal balance morespecifically, we can also use the re-gression results in a more precisemanner: if we put the coefficient onthe fiscal rule index to zero (or inan alternative interpretation, if thefiscal rule index always had a valueof zero) in the estimated fiscal bal-ance equation estimated in column(1) of Table 2, we would obtain anestimate of the fiscal balance in thehypothetical case that fiscal ruleshad no effect on fiscal disciplineand therefore on fiscal balances.

Figure 2 provides for Belgium the estimated fiscalbalance according to (1).The estimated impact of fis-cal rules on the fiscal balance is defined as the dif-ference between Fiscal Balance I (blue line: fiscalbalance if fiscal rules are ineffective, viz., fiscal rulesare non-existent) and Fiscal Balance II (red line: fis-cal balance with effect of fiscal rules according topanel estimation 1). As can be seen, the estimatedimpact of fiscal rules is not negligible.

We can take the analysis even one step further by re-estimating panel estimation (1) and allowing coun-try-specific slope coefficients for the fiscal rule indexvariable. In that case we allow for the possibility thatcountries differ in the way fiscal rules impact on fis-cal variables; in the panel estimations in Table 2 suchcountry-specific elasticities for the Fiscal Rules In-dex were not considered. In the case of Belgium, thisincreases even further the estimated effect of fiscalrules: to see this, consider Fiscal Balance II and FiscalBalance III (green line, deficit with effect fiscal rules

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2 We also estimated (1)-(8) for the entiresample of EU countries. In that case,results are largely consistent with Table 2.

-5

-4

-3

-2

-1

0

119

96

1998

2000

2002

2004

2006

2008

2010

-6

-5

-4

-3

-2

-1

0

1

2

1996

1998

2000

2002

2004

2006

2008

2010

-5

-4

-3

-2

-1

0

1

1996

1998

2000

2002

2004

2006

2008

2010

-6

-5

-4

-3

-2

-1

0

1

2

1996

1998

2000

2002

2004

2006

2008

2010

ESTIMATED EFFECTS OF FISCAL RULES

Belgium Austria

-6

-5

-4

-3

-2

-1

0

1

1996

1998

2000

2002

2004

2006

2008

2010

-9

-8

-7

-6

-5

-4

-3

-2

1996

1998

2000

2002

2004

2006

2008

2010

%

Source: Own calculations.Fiscal Balance I Fiscal Balance III Fiscal Balance II

%

Spain Netherlands

Germany Greece

% %

% %

Figure 2

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according to panel estimation with country-specificFRI-slopes) in Figure 2. With country-specific esti-mates of the Fiscal Rules effect on the fiscal balance,the estimated fiscal rules coefficient in case ofBelgium, is more than double in size compared tothe original panel estimation that assumes equalslopes across the euro area countries. In the case ofBelgium, the estimated difference is the largest of allcountries. In other countries the difference with thefirst panel estimation without country-specific slopesis smaller. According to this estimation, the deficitmoderating effect of fiscal rules can improve the fis-cal balance by as much as 1 percent.

In a similar vein, we find for Austria that the effect ofthe fiscal rules is much smaller. In the case of Spainthe effect of fiscal rules on the fiscal deficit is initial-ly also small, but increases consistently over time.Also for the Netherlands, the fiscal rules have someimpact on moderating fiscal deficits and in this casethere is no distinguishable difference between thepanel estimation without and the estimation withcountry-specific slopes on the fiscal rules index. Inthe case of Germany, the effect of the fiscal rulesindex decreases in the panel regression with country-specific slopes on this variable. Greece is a specialcase: its fiscal rule index reached the lowest (andnegative) score of all countries. Given a positive co-efficient in the panel estimation without and withcountry-specific slope on the FRI, this would implythat the inadequate fiscal rules in Greece actuallycontributed to a higher fiscal deficit. Taken together,these findings suggest that fiscal rules exert a non-negligible effect on fiscal balances in the euro area,even if the effects may differ somewhat betweencountries and over time.

Conclusion

The recent fiscal turmoil in the euro area, casts somedoubts on the adequacy of the Stability and GrowthPact in delivering fiscal stringency as it did notachieve satisfactory results in practice. Practically allEU countries are implementing and prolonging theapplication of (sub)national fiscal rules; the pactseems to be insufficient and redundant consideringthe numerous domestic rules. At the same time,many of those domestic rules do not seem effectiveenough to devolve all fiscal power on member states.Since another reform of the pact is improbable in theshort run, the only solution to the problem is to main-tain the pact’s fiscal constraints and complement

them with better co-ordinated national fiscal rules.Our empirical estimates indicate that the existingframework of national fiscal rules – notwithstandingthe inconsistencies in design, implementation andenforcement – exerts a non-negligible effect on fiscalvariables in the euro area, even if the effects may dif-fer between countries and over time reflecting theidiosyncrasies of fiscal management and (changesin) the framework of national fiscal rules.

References

Ballabriga F. and C. Martinez-Mongay (2003), “Has EMU ShiftedMonetary and Fiscal Policies?” in M. Buti, ed., Monetary and FiscalPolicies in EMU: Interactions and Coordination, Cambridge Uni-versity Press, Cambridge.

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