CESifo Economic Studies Advance Access published online on February 26, 2007
CESifo Economic Studies, doi:10.1093/cesifo/ifm003
| ||||||||||||||||||||||||||||||||||||||||||||||||||||
From Deficits to Debt and Back: Political Incentives under Numerical Fiscal Rules
* European Comission DG ECFIN, B-1049 Brussels, Belgium.
Under numerical fiscal rules, such as those underpinning EMU, governments have strong temptations to use accounting tricks to meet the fiscal constraints. Given these political incentives, fiscal variables that in the past were regarded as a mere residual acquire a strategic role. This is the case of the so-called stock-flow adjustment (SFA) which reconciles deficit and debt developments. We develop a simple theoretical model where deficits and two distinct SFA components (one that could be used to reduce the deficit figures and the other to impact debt figures instead) are determined as a result of a constrained optimisation by fiscal authorities. Econometric evidence provides results consistent with the model findings. The SFA component related to the purpose to hide deficits rises with the recorded deficit, while the sales of financial assets designed to keep the debt under control rise with both debt and deficit. When deficits are in excess of the 3 percent limit, accounting gimmicks become more sensitive to the size of deficits. The SGP per se does not appear to increase the extent to which higher deficits trigger more accounting gimmicks. However, the SGP seems associated with a more intense use of accounting gimmicks irrespective of the level of deficit. Such accounting practices have greatly contributed to the loss of credibility of Economic and Monetary Union's fiscal rules. If properly implemented, the reformed Pact, which stresses durable adjustment and long-run sustainability, should help curb such perverse incentives. (JEL codes: E61, H62, H87)
Key Words: Stability and Growth pact • government accounting • stock-flow adjustment • fiscal gimmicks
European Comission and CEPR, European Commission, DGECFIN, B-1049 Brussels, Belgium. e-mail: alessandro{at}turrini.ec.europa.euThe views expressed in this article are those of the authors and do not necessarily reflect those of the European Commission. We would like to thank an anonymous referee, Fabrizio Balassone, Mark De Broeck, Xavier Debrun, Elena Flores, Luca Onorante, Karsten Wendorff, Guntram Wolff and several participants at the 8th Banca d’ Italia Workshop on Public Finance, Perugia, 30 March–1 April. We also thank V. Ernesto Reitano and Vittorio Gargaro for excellent research assistance.