Fiscal Discretion and Elections in the Early Years of EMU

Abstract

An early criticism of the Stability and Growth Pact (SGP) has pointed to its asymmetric nature and the weak mechanisms to prevent politically-motivated fiscal policies: its constraints would bite in downswings but not in upswings, especially if, in the latter, the electoral cycle increases the temptation to run expansionary policies. We find that the experience of the initial years of EMU lends support to this criticism. Overall, unlike the experience in the run-up to EMU, fiscal policies had an expansionary bias, and a 'genuine' discretionary boost took place in correspondence to political elections. Both sign and composition of such discretionary changes are in line with the predictions of the recent literature on electoral budget cycles. Closer fiscal surveillance may help detect such behaviour early on, but it is unlikely to curb the incentives to run politically-motivated fiscal policies when elections approach. Copyright Blackwell Publishing Ltd 2004.

Business taxes and the electoral cycle

“…1 Hallerberg, Strauch, and von Hagen (2007) show that public debt of European Union countries tends to increase more in election years. In particular after the set-up of the European Monetary Union members of the Eurozone have systematically run fiscal expansions during election years (Buti and van den Noord, 2003;von Hagen, 2006;Mink and de Haan, 2005;Efthyvoulou, 2012). Similar evidence for an effect of elections on debt in OECD countries is found by Alt and Dreyer Lassen (2006).…”

Estimating the effect of the EMU on current account balances: A synthetic control approach

“…It set out the restrictions on the deficits and debt that member state governments could accumulate. However, its weak enforcement mechanisms and the lack of constraints on fiscal policy during upswings led to both expansionary fiscal stances in boom times and the return of politically-motivated fiscal boosts in election years (Buti and Van Den Noord, 2004;Efthyvoulou, 2012;Mink and De Haan, 2006). The threat of politically costly reprimands and fines that came with the SGP also increased the incentives of…”

“…Schmitz and von Hagen (2011) and Hale and Obstfeld (2016) find evidence that the EMU significantly increased capital flows from the relatively richer northern member states to the relatively poorer southern member states. There are also a number of empirical studies that find that the EMU led to an increase in expansionary and electorallymotivated fiscal policy (Buti and Van Den Noord, 2004;Efthyvoulou, 2012;Mink and De Haan, 2006), as well as a rise in overly optimistic budget deficit forecasts aimed at misleading electorates, especially in the run up to elections (Brück and Stephan, 2006). In turn, there is also robust evidence that fiscal policy expansions in EMU countries result in a deterioration in the trade balance (Beetsma and Giuliodori, 2010;Bénétrix and Lane, 2010).…”

Breaking the Stability Pact: Was it predictable?

“…Obviously, this short-termism makes sense only in a world where the Barro-Ricardo equivalence does not hold, namely in a world where private agents have finite lives and do not fully care about the well-being of their descendants, or are bequest constrained, or suffer from incomplete information or from bounded rationality (thus being subject to "fiscal illusion") (e.g. Blanchard, 1985;Cukierman and Meltzer, 1989;Persson and Tabellini, 1990;Buti and van den Noord, 2003).…”