A Fiscal Rule that Has Teeth: A Suggestion for a “Fiscal Sustainability Council” Underpinned by the Financial Markets
AbstractIn this paper, we set out to examine an efficient fiscal-policy framework for a monetary union. We illustrate that fiscal policy’s bias toward budget deficit only temporarily ceased at the end of the 20th century as European countries endeavored to qualify for euro-zone membership, which compelled strict limits on budgetary deficits. We then explore which mechanisms might instill a sense of fiscal disciple in governments. We find that most mechanisms suffer from the incentive-incompatible setup whereby governments restrict their own fiscal-policy freedom. We argue that even multilateral fiscal rules, such as the EU’s Stability and Growth Pact, suffer from the same endogeneity flaw. Consequently, we argue that a fiscal rule must incorporate an external authority that would impartially assess fiscal-policy developments. Using U.S. debt and bond-market data at the state level, we show that financial markets represent a good candidate as, vis-à-vis the American states, they do differentiate state debt according to the level of debt. We thus argue for a fiscal institution – what we call the Fiscal Sustainability Council– that would actively bring financial markets into the fiscal-policy process, and we explain the technique whereby this could be effected.
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Bibliographic InfoArticle provided by Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies in its journal AUCO Czech Economic Review.
Volume (Year): 1 (2007)
Issue (Month): 1 (March)
Other versions of this item:
- Petr Hedbávný & Ondrej Schneider & Jan Zápal, 2005. "A Fiscal Rule that has Teeth: A Suggestion for a ‘Fiscal Sustainability Council’ underpinned by the Financial Markets," CESifo Working Paper Series 1499, CESifo Group Munich.
- Petr Hedbávný & Ondřej Schneider & Jan Zápal, 2005. "A Fiscal Rule That Has Teeth: A Suggestion for a "Fiscal Sustainability Council" Underpinned by the Financial Markets," Working Papers IES 79, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised 2005.
- E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
- H6 - Public Economics - - National Budget, Deficit, and Debt
- H87 - Public Economics - - Miscellaneous Issues - - - International Fiscal Issues; International Public Goods
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