EMU Fiscal Rules: A New Answer to an Old Question?

Abstract

A b s tr a c t EMU fiscal rules aim at ensuring sound fiscal policies in EU Member States while allowing sufficient margins for stabilisation policy. The Treaty of Maastricht and the Stability and Growth Pact introduced a detailed framework of rules, surveillance procedures and sanctions that are tighter than those generally applying in federal countries. In this paper we try to assess to what extent the issue facing the founders of EMU was a new one in the field of public finance and to what extent the solution chosen can be regarded as innovative. To this end, we review the literature on budgetary rules from its very beginning to the years immediately before the Treaty of Maastricht. We consider the arguments brought forward to justify EMU fiscal rules and the novel feature of the problem faced at the EU level, represented by the interaction between its multinational nature and the lack of a political authority of federal rank. The solutions chosen, while drawing heavily on ideas that were central in the debate on fiscal rules, reflect this new aspect of the problem. The highly decentralised setting of fiscal policy in EMU gave prominence to moral hazard issues; it is probably at the roots of the rejection of both the dual budget approach and the distinction between ordinary and extraordinary finance; it motivated the adoption of a detailed multilateral surveillance procedure and the introduction of a predetermined limit for the annual deficit in a framework that envisages the targeting of a balanced budget over the cycle.

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“…The application of Say's law implies a full utilization of productive resources, hence no involuntary unemployment, nor idle resources in the system (Arestis and Sawyer 2003). This also means that fiscal deficit is useless because, paraphrasing Smith, "government borrowing would deprive society of resources which could be invested more productively" (Balassone and Franco 2001).…”

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“…Larger deficits are considered "excessive" unless "the excess over the reference value is only exceptional and temporary and the ratio remains close to the reference value". The formal wording of this escape clause must be regarded as quite stringent, as all the conditions in it must in principle be fulfilled for it to apply (Balassone and Franco, 2001;Buti and Giudice, 2002). According to the SGP, the exceptionality condition can refer either to "an unusual event outside the control of the Member State in question which has a major impact on the financial position of the general government" or to an "abrupt cyclical downturn".…”

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“…EMU fiscal rules reflect the interaction between the multinational nature of EMU and the lack of a political authority of federal rank (Balassone and Franco, 2001). This has important implications.…”

“…However, there are a number of arguments against the introduction of the golden rule (Balassone and Franco, 2000;Buiter, 2001).…”

“…Stock-flow effects have systematically contributed to debt growth. A way to tackle this issue is to resurrect, in parallel with national accounts definitions, regular monitoring of cash flows (Balassone et al, 2002). National authorities would be required to indicate ex-ante cash figures broadly consistent with the European system of national accounts (ESA95) balance.…”