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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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  • Hagen, Jürgen von
  • Wolff, Guntram B.

Abstract

Fiscal rules, such as the Excessive Deficit Procedure and the Stability and Growth Pact (SGP), aim at constraining government behavior. Milesi-Ferretti (2003) develops a model in which governments circumvent such rules by reverting to creative accounting. The amount of this depends on the reputation cost for the government and the economic cost of sticking to the rule. 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. The 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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Paper provided by Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich in its series Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems with number 148.

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Date of creation: Jan 2006
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Handle: RePEc:trf:wpaper:148

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Keywords: Fiscal rules; stock-flow adjustments; debt-deficit adjustments; stability and growth pact; excessive deficit procedure; ESA 95;

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  1. von Hagen, Jurgen, 1991. "A note on the empirical effectiveness of formal fiscal restraints," Journal of Public Economics, Elsevier, vol. 44(2), pages 199-210, March.
  2. International Monetary Fund, 1996. "Budget Processes and Commitment to Fiscal Discipline," IMF Working Papers 96/78, International Monetary Fund.
  3. 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, Elsevier, vol. 45(1), pages 13-76, December.
  4. Gian-Maria Milesi-Ferretti, 2000. "Good, Bad or Ugly?on the Effects of Fiscal Rules with Creative Accounting," IMF Working Papers 00/172, International Monetary Fund.
  5. James M. Poterba, 1993. "State Responses to Fiscal Crisis: The Effects of Budgetary Institutionsand Politics," NBER Working Papers 4375, National Bureau of Economic Research, Inc.
  6. 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, Wharton School Rodney L. White Center for Financial Research 10-96, Wharton School Rodney L. White Center for Financial Research.
  7. 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, Wiley Blackwell, vol. 58(2), pages 277-97, April.
  8. Kenji Moriyama & Gian-Maria Milesi-Ferretti, 2004. "Fiscal Adjustment in Eu Countries," IMF Working Papers 04/143, International Monetary Fund.
  9. Fabrizio Balassone & Daniele Franco & Stefania Zotteri, 2006. "EMU fiscal indicators: a misleading compass?," Empirica, Springer, Springer, vol. 33(2), pages 63-87, June.
  10. Jürgen von Hagen, 2002. "Fiscal Rules, Fiscal Institutions, and Fiscal Performance," The Economic and Social Review, Economic and Social Studies, Economic and Social Studies, vol. 33(3), pages 263-284.
  11. 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.
  12. Dafflon, Bernard & Rossi, Sergio, 1999. " Public Accounting Fudges towards EMU: A First Empirical Survey and Some Public Choice Considerations," Public Choice, Springer, Springer, vol. 101(1-2), pages 59-84, October.
  13. 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, Oxford University Press, vol. 12(1), pages 62-97, April.
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