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A Fiscal Rule that has Teeth: A Suggestion for a ‘Fiscal Sustainability Council’ underpinned by the Financial Markets

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  • Petr Hedbávný
  • Ondrej Schneider
  • Jan Zápal

Abstract

In 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 Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 1499.

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Date of creation: 2005
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Handle: RePEc:ces:ceswps:_1499

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Keywords: fiscal policy; European Union; sustainability;

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Cited by:
  1. Ondøej Schneider, 2009. "Reforming Pensions in Europe: Economic Fundamentals and Political Factors," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, Charles University Prague, Faculty of Social Sciences, vol. 59(4), pages 292-308, Oktober.

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