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Stress testing the EU fiscal framework

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  • Masten, Igor
  • Grdović Gnip, Ana

Abstract

This study evaluates the efficiency of the cyclically-adjusted budget balance (CABB) as the central gauge in the reinforced European fiscal framework for evaluating fiscal discipline. We do this by means of a simulation experiment. We use an estimated DSGE model to simulate all the macroeconomic data needed to assess the CABB according to the official EC methodology. Additionally, the model contains an expenditure fiscal rule that accounts for non-automatic variation in the budget, which allows us to observe the true discretionary measures of fiscal policy. Our results indicate that the EC methodology frequently fails to identify the true fiscal policy stance and also frequently fails to correctly signal potential violations of the SGP limit on structural deficit. In the latter case triggering corrective fiscal contractions to comply with the SGP results in increased macroeconomic instability. In addition, we show that allowing for a bigger role for stability-oriented discretionary policy and thus relaxing the SGP limit on structural deficit could enhance the stabilization efficiency of fiscal policy without reducing the degree of compliance with the Maastricht Treaty. These conclusions apply to small countries in a monetary union as well as large countries with independent monetary policy.

Suggested Citation

  • Masten, Igor & Grdović Gnip, Ana, 2016. "Stress testing the EU fiscal framework," Journal of Financial Stability, Elsevier, vol. 26(C), pages 276-293.
  • Handle: RePEc:eee:finsta:v:26:y:2016:i:c:p:276-293
    DOI: 10.1016/j.jfs.2016.07.011
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    2. L. Marattin & S. Meraglia, 2016. "Potential Output and Fiscal Rules in a Monetary Union under Asymmetric Information 2nd ed," Working Papers wp1063, Dipartimento Scienze Economiche, Universita' di Bologna.

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    More about this item

    Keywords

    Cyclically-adjusted budget balance; Structural deficit; Fiscal policy; EU fiscal governance; SGP; Great Recession; DSGE; Stress test;
    All these keywords.

    JEL classification:

    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus

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