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What do deficits tell us about debt? Empirical evidence on creative accounting with fiscal rules in the EU

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  • von Hagen, Jurgen
  • Wolff, Guntram B.

Abstract

Fiscal rules, such as the excessive deficit procedure and the stability and growth pact (SGP), aim at constraining government behaviour. Milesi-Ferretti (2003) develops a model in which governments circumvent such rules by reverting to creative accounting. The amount of this creative accounting depends on the reputation cost for the government and the economic cost of sticking to the rule. In this Paper, we provide empirical evidence of creative accounting in the European Union. We find that the SGP rules have induced governments to use stock-flow adjustments, a form of creative accounting, to hide deficits. This tendency to substitute stock-flow adjustments for budget deficits is especially strong for the cyclical component of the deficit, as in times of recession the cost of reducing the deficit is particularly large.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 30 (2006)
Issue (Month): 12 (December)
Pages: 3259-3279

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Handle: RePEc:eee:jbfina:v:30:y:2006:i:12:p:3259-3279

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  1. Poterba, James M, 1994. "State Responses to Fiscal Crises: The Effects of Budgetary Institutions and Politics," Journal of Political Economy, University of Chicago Press, vol. 102(4), pages 799-821, August.
  2. Bohn, Henning & Inman, Robert P., 1996. "Balanced-budget rules and public deficits: evidence from the U.S. states," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 45(1), pages 13-76, December.
  3. Milesi-Ferretti, Gian Maria, 2001. "Good, Bad or Ugly? On the Effects of Fiscal Rules with Creative Accounting," CEPR Discussion Papers 2663, C.E.P.R. Discussion Papers.
  4. Henning Bohn & Robert P. Inman, . "Balanced Budget Rules and Public Deficits: Evidence from the U.S. States (Reprint 060)," Rodney L. White Center for Financial Research Working Papers 10-96, Wharton School Rodney L. White Center for Financial Research.
  5. Blejer, Mario I & Cheasty, Adrienne, 1991. "The Measurement of Fiscal Deficits: Analytical and Methodological Issues," Journal of Economic Literature, American Economic Association, vol. 29(4), pages 1644-78, December.
  6. Kiewiet, D Roderick & Szakaly, Kristin, 1996. "Constitutional Limitations on Borrowing: An Analysis of State Bonded Indebtedness," Journal of Law, Economics and Organization, Oxford University Press, vol. 12(1), pages 62-97, April.
  7. von Hagen,Juergen, . "A note on the empirical effectiveness of formal fiscal restraints," Discussion Paper Serie B 155, University of Bonn, Germany.
  8. Arellano, Manuel & Bond, Stephen, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 277-97, April.
  9. Dafflon, Bernard & Rossi, Sergio, 1999. " Public Accounting Fudges towards EMU: A First Empirical Survey and Some Public Choice Considerations," Public Choice, Springer, vol. 101(1-2), pages 59-84, October.
  10. International Monetary Fund, 1996. "Budget Processes and Commitment to Fiscal Discipline," IMF Working Papers 96/78, International Monetary Fund.
  11. Jürgen von Hagen, 2002. "Fiscal Rules, Fiscal Institutions, and Fiscal Performance," The Economic and Social Review, Economic and Social Studies, vol. 33(3), pages 263-284.
  12. Fabrizio Balassone & Daniele Franco & Stefania Zotteri, 2006. "EMU fiscal indicators: a misleading compass?," Empirica, Springer, vol. 33(2), pages 63-87, June.
  13. Kenji Moriyama & Gian-Maria Milesi-Ferretti, 2004. "Fiscal Adjustment in Eu Countries," IMF Working Papers 04/143, International Monetary Fund.
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