Point break: When fiscal rules turn pro-cyclical – Evidence from debt thresholds in the European Union

This paper studies whether, and above which level of public debt, fiscal rules in the European Union become associated with systematically more pro-cyclical discretionary fiscal policy. We combine three elements that are rarely brought together in the same empirical framework: real-time ex ante fiscal plans and output-gap forecasts, time-varying estimates of fiscal cyclicality, and an identification strategy that addresses the simultaneity between fiscal policy and cyclical conditions. Using European Commission Autumn forecast vintages for 26 EU countries over 2008-2019, we first recover annual country-specific measures of planned discretionary fiscal cyclicality. To do so, we complement a Schlicht-type time-varying coefficient model with a kernel-based time-varying instrumental-variable estimator, instrumenting domestic cyclical conditions with a country-specific external-demand shifter. We then relate the estimated cyclicality coefficients to the strength of fiscal rules, measured through continuous indices based on both the IMF Fiscal Rules Dataset and the European Commission methodology, and allow for non-linearities through panel threshold methods. We find a robust debt threshold around 88 per cent of GDP. Above this threshold, stronger fiscal rules are associated with significantly more pro-cyclical discretionary fiscal behaviour; below it, the relationship is weak and generally not statistically distinguishable from zero. The result is robust across alternative rule indices, specifications, and estimation strategies, and is especially strong in the time-varying IV estimates. The evidence also shows that the Maastricht 60 per cent debt benchmark does not coincide with the empirically relevant regime shift in the stabilisation properties of fiscal rules. The findings suggest that, in persistently high-debt environments, rule-based surveillance may intensify cyclical pressures unless flexibility is explicitly designed around debt-contingent stabilisation needs.