Skip to main content

Valuable legacy? The effect of inherited fiscal rules

Abstract

The working mechanism of national fiscal rules depends strongly on whether a government must comply with its own rules or inherited ones. In the former case, a government usually introduces fiscal rules to show its commitment to a disciplined fiscal policy (the signaling function). In the latter context, however, inherited rules constitute external obstacles to budgetary policymaking (the limiting function). This study mainly is concerned with the limiting function and therefore bases its empirical analysis on periods when the ruling government inherited fiscal rules introduced by a previous government. The results of a panel-data econometric study indicate that national fiscal rules do contribute to disciplined fiscal policy after a change in government in times of an economic upturn. That finding, however, does not mean that the signaling function is ineffective: quite the contrary. My results, in line with the literature, indicate that the double functions of rules may complement one another. A government that introduces such rules is often already committed to a disciplined policy and wishes to signal such commitment in the short term. With the appearance of new government, however, the function of rules changes, and they efficiently promote disciplined fiscal policy in the long term.

This is a preview of subscription content, access via your institution.

Fig. 1
Fig. 2
Fig. 3
Fig. 4
Fig. 5
Fig. 6

Notes

  1. The actual goal of fiscal rules may differ from country to country, but as I refer to it later, one of the main goals is to ensure macroeconomic stability by restraining deficit bias (Kennedy and Robbins 2001).

  2. A new approach was introduced by Grembi et al. (2016), who applied a quasi-experimental method to study the effects of fiscal rules among local governments in Italy.

  3. Notably, just as Persson and Svensson (1989) emphasized that (building up the) public debt can be a tool in the hands of the departing government to limit the fiscal space of its successor, the same is true of fiscal rules. If the government is unlikely to win in the next election, decision makers can be motivated to complicate the fiscal situation faced by the next government by creating new budgetary rules.

  4. To be comparable to the literature, I also carried out our estimations in terms of the cyclically adjusted primary balance, and I obtained similar results.

  5. The FRI is the simple sum of FRSI by year and by country computed such that at the last step of aggregation, the complete database, ranging from the first year to the last one, is transformed into a zero-mean, one-standard-error distribution. The smallest possible value of the index is − 1.01 when no fiscal rule is in force in a country in a given year, whereas the largest value is 2.13.

  6. Bergman et al. (2016) used the database containing the International Monetary Fund's (IMF’s) budgetary rules and concluded that fiscal rules are able to reduce structural public budget deficits.

  7. The picture that Heinemann et al. (2014) draw is made more ambiguous by empirical evidence suggesting that fiscal rules can contribute to reducing risk premiums in countries with rather weak cultures of stability.

  8. I intentionally ignore the fiscal rules of the EU itself, mainly because the nature of those rules differs from the nature of national rules in many aspects (legal background, validity and the like). However, later in the regression estimations, I use a variable (EURO) that captures the effort of member countries to pursue disciplined fiscal policy in order to adopt the euro as their national currency in 2001. As the numerical details of the necessary fiscal conditions for joining the eurozone are contained in the Maastricht Treaty, from 2001 on, I consider those supranational rules, which turn out to have had the strongest influence on public budget balances in the investigated period.

  9. Similar to our study, the primary balance also is used by Marneffe et al. (2010), Afonso and Hauptmeier (2009) and Cordes et al. (2015).

  10. In the cases of Austria, Bulgaria, Estonia, Latvia and Portugal, my questions were answered with the help of a coworker, the leader of the local fiscal council or central bank, or a local economist with expertise in national fiscal policy.

  11. Certainly, the size of the fiscal expansion must also be limited during crises, but so far, no consensus has emerged about the threshold, which makes it difficult to evaluate the efficiency of fiscal rules from that perspective. For more details on the mechanism of fiscal rules in recessions, see Hong (2015).

  12. Fiscal rules may incentivize decision makers to comply with the rules through informal methods (e.g., creative accounting, manipulating), but in this paper, we can measure only the consequences that are captured by a fiscal balance indicator.

  13. The results do not change if the threshold value is 0, as I will show below.

  14. The description of the index is summarized in Sect. 2.

  15. Estimated with a Hodrick–Prescott filter (Source: AMECO).

  16. To check the potential bias caused by different measures of GDP in both the dependent and explanatory variables, I considered different specifications with different dependent variables. First, I used the primary balance of trend GDP instead of the primary balance of GDP; second, I used the primary balance per capita in millions of euros. The qualitative conclusions from the model did not change, as the FRI remained significant.

  17. As in the case of cross-section regression to check the potential bias that may be caused by measures of GDP in both the dependent and explanatory variables, I examined different specifications with different dependent variables for all observations. First, I used the primary balance of trend GDP instead of the primary balance of GDP; second, I used public balance per capita in millions of euros. The qualitative conclusions from the model did not change, as the FRI remained significant.

  18. The sum of the FRI and the coefficients of the interaction did not prove to be significant in this case, so their sum cannot be interpreted.

  19. The sum of the two coefficients also proved to be significant (P = 0.006).

  20. The sum of the FRI and the interaction coefficient was not significant.

  21. Because of multicollinearity, I ran the regression by omitting FRI and GAP3 from the right-hand side of the equation; in that case, their interaction (FRI * GAP3) was still significant, and the coefficient was 0.96.

  22. In the first step, I used the Database of Political Institutions 2015 (Cruz et al. 2016) and computed a dummy variable to capture the government’s ideology. The size and significance of the coefficient of the interaction remained the same (see the results reported in Table 8 in Appendix). To check my findings, I repeated the estimation with a new variable from another dataset. The Comparative Political Data Set 1960–2014 (Armingeon et al. 2017) contains a variable that measures the cabinet posts of right-wing parties as a percentage of total cabinet posts. The findings were the same: the size and significance of the interaction of the FRI and GAP3 remained unchanged.

  23. The results of the estimation of the basic model as well as the estimation without the interaction term are found in Table 9 in Appendix.

  24. The interaction coefficient was 0.96 and significant. Detailed results are shown in Table 10 in Appendix.

  25. As with all other studies in the literature, they combined all kinds of fiscal rules, including both inherited and own rules.

References

  • Afonso, A., & Hauptmeier, S. (2009). Fiscal behavior in the European Union: Rules, fiscal decentralization and government indebtedness. ECB Working Paper No. 1054.

  • Alesina, A., Campante, F. R., & Tabellini, G. (2008). Why is fiscal policy often procyclical? Journal of the European Economic Association, 6(5), 1006–1036.

    Article  Google Scholar 

  • Arellano, M., & Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment balances. The Review of Economic Studies, 58(2), 277–297.

    Article  Google Scholar 

  • Armingeon, K., Wenger, V., Wiedemeier, F., Isler, C., Knöpfel, L., Weisstanner, D., et al. (2017). Comparative political data set 1960–2014. Bern: Institute of Political Science, University of Berne.

    Google Scholar 

  • Ayuso-i-Casals, J., Hernández, D. G., Moulin, L., & Turrini, A. (2009). Beyond the SGP: Features and effects of EU national-level fiscal rules. In Ayuso-i-Casals, J., Deroose, S., Flores, E., & Moulin, L. (Eds.), Policy instruments for sound fiscal policies (pp. 204–240). Palgrave Macmillan.

  • Balatoni, A. (2015). A simple fiscal rule for Hungary. Acta Oeconomica, 65(1), 149–159.

    Article  Google Scholar 

  • Balázsi, L., Divényi, J., Kézdi, G., & Mátyás, L. (2014). A közgazdasági adatforradalom és a panelökonometria. Közgazdasági Szemle, 61(11), 1319–1340.

    Google Scholar 

  • Bayoumi, T., Goldstein, M., & Woglom, G. (1995). Do credit markets discipline sovereign borrowers? Evidence from US states. Journal of Money, Credit and Banking, 27(4), 1046–1059.

    Article  Google Scholar 

  • Benczes, I. (2011). Nemzeti szintű fiskális szabályok használata az Európai Unióban. Külgazdaság, 55(4–3), 55–75.

    Google Scholar 

  • Benecki, R., Hölscher, J., & Jarmuzek, M. (2009). Fiscal transparency and policy rules in Poland. CASE Network Studies and Analysis 327. London.

  • Bergman, U. M., Hutchison, M. M., & Jensen, S. E. H. (2013). Do sound public finances require fiscal rules or is market pressure enough? European Commission, European Economy. Economic Papers No. 489 (April).

  • Bergman, U. M., Hutchison, M. M., & Jensen, S. E. H. (2014). Phoenix rising from the ashes: New evidence on national fiscal rules in the EU. Conference paper. Swedish Network for European Studies in Economics and Business (SNEE) on European Integration, Mölle, Sweden.

  • Bergman, U. M., Hutchison, M. M., & Jensen, S. E. H. (2016). Promoting sustainable public finances in the European Union: The role of fiscal rules and government efficiency. European Journal of Political Economy, 44, 1–19.

    Article  Google Scholar 

  • Berndsen, R. (2001). Postwar fiscal rules in the Netherlands: What can we learn for EMU? Proceedings of the Banca d’Italia Public Finance Workshop, 2001, 367–380.

    Google Scholar 

  • Bohn, H. (1998). The behavior of U.S. public debt and deficits. The Quarterly Journal of Economics, 113(3), 949–963.

    Article  Google Scholar 

  • Bova, E., Carcenac, N., & Guerguil, M. (2014). Fiscal rules and the procyclicality of fiscal policy in the developing world. IMF Working Paper, WP/14/122.

  • Brender, A., & Drazen, A. (2005). Political budget cycles in new versus established democracies. Journal of monetary Economics, 52(7), 1271–1295.

    Article  Google Scholar 

  • Checherita-Westphal, C., & Ždarek V. (2015). Fiscal reaction function and fiscal fatigue in the euro area. In Public Finance Workshop, Hrvatska narodna banka, Zagreb.

  • Christoffel, K., Jaccard, I., & Kilponen, J. (2010). Bond risk premium, fiscal rules and monetary policy: An estimated DGSE approach. Frankfurt: European Central Bank.

    Google Scholar 

  • Cordes, T., Kinda, T., Muthoora, P., & Anke W. (2015). Expenditure rules: Effective tools for sound fiscal policy? IMF Working Paper 15/29.

  • Cottarelli, C., Gerson, P., & Senhadji, A. (2014). Post-crisis fiscal policy. Cambridge: MIT Press.

    Book  Google Scholar 

  • Cruz, C., Keefer, P., & Scartascini, C. (2016). Database of political institutions codebook, 2015 update (DPI2015). Washington: Inter-American Development Bank.

    Google Scholar 

  • Dahan, M., & Strawczynski, M. (2010). Fiscal rules and composition bias in OECD countries. CESIFO Working Paper No. 3088.

  • Darvas, Z. S., & Kostyleva, V. (2011). The fiscal and monetary institutions of CE-SEE countries. Bruegel Working Paper, No. 2.

  • Debrun, X., & Kumar, M. (2007). Fiscal rules, fiscal councils and all that: Commitment devices, signaling tools or smokescreens? In Proceedings of the 9th Banca d’Italia workshop on public finance. Rome: Banca d’Italia.

  • Debrun, X., Moulin, L., Turrini, A., Ayuso-i-Casals, J., & Kumar, S. M. (2008). Tied to the mast? National fiscal rules in the European Union. Economic Policy, 23(54), 298–362.

    Article  Google Scholar 

  • Deroose, S., Schaechter, A., & Larch, M. (2008). Constricted, lame and pro-cyclical? Fiscal policy in the euro area revisited. Economic papers No. 353. European Commission, DG ECFIN.

  • DuPont, J., & Kwarteng, K. (2012). Binding the hands of government: A credible fiscal rule for the UK. In IEA Current Controversies Paper 36, May, London

  • European Commission. (2006). Numerical fiscal rules in the EU member states. In Public finances in EMU. European Economy No. 3, Part III, chapter 3 (pp. 149–168). European Commission.

  • European Commission. (2009). Numerical fiscal rules in the EU member states in 2008. In Public finances in EMU. Part II, chapter 4, [pages]. European Commission.

  • European Commission. (2015). Fiscal rules database (old methodology). http://ec.europa.eu/economy_finance/db_indicators/fiscal_governance/fiscal_rules/index_en.htm. Accessed 01 Sept 2015.

  • Grembi, V., Nannicini, T., & Troiano, U. (2016). Do fiscal rules matter? American Economic Journal: Applied Economics, 8(3), 1–30.

    Google Scholar 

  • Hallerberg, M., & Von Hagen, J. (2006). Budget processes in Poland: Promoting fiscal and economic stability. Warsaw: Ernst and Young Better Government Program.

    Google Scholar 

  • Heinemann, F., Moessinger, M., & Daniel-Yeter, M. (2016). Do fiscal rules constrain fiscal policy? A meta-regression-analysis. ZEW Discussion Paper No. 16-027.

  • Heinemann, F., Osterloh, S., & Kalb, A. (2014). Sovereign risk premia: The link between fiscal rules and stability culture. In ZEW Discussion Papers 13-016. ZEW—Zentrum für Europäische Wirtschaftsforschung/Center for European Economic Research.

  • Heinemann, F., & Yeter, M. (2014). The effects of fiscal rules on public finances and their identification. Conference Paper. Evidenzbasierte Wirtschaftspolitik - Session: Fiscal Sustainability, No. B20-V1.

  • Hemming, R., & Kell, M. (2001). Promoting fiscal responsibility: Transparency, rules and independent fiscal authorities. In Banca d’Italia (Ed.), Fiscal rules, proceedings of the fiscal policy workshop held in Perugia, February 1–3 (pp. 433–459). Rome, Banca d’Italia.

  • Holm-Hadulla, F., Hauptmeier, S., & Rother, P. (2012). The impact of expenditure rules on budgetary discipline over the cycle. Applied Economics, 44(25), 3287–3296.

    Article  Google Scholar 

  • Hong, S. (2015). Fiscal rules in recessions: Evidence from the American states. Public Finance Review, 43(4), 505–528.

    Article  Google Scholar 

  • Iara, A., & Wolff, G. B. (2010). Rules and risk in the euro area: does rules-based national fiscal governance contain sovereign bond spreads? European Economy—Economic Papers 433, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission,

  • Kennedy, S., & Robbins, J. (2001). The role of fiscal rules in determining fiscal performance. Department of Finance Canada, Working Paper, No. 16.

  • Kiss, G. P. (2012). Distinkció és kikényszeríthetőség—a fiskális szabályrendszer alfája és ómegája. Pázmány Law Working Papers, No. 39.

  • Kopits, G. Y. (2001). Fiscal rules: Useful policy framework or unnecessary ornament. IMF Working Paper, No. 145.

  • Krogstrup, S., & Wälti, S. (2008). Do fiscal rules cause budgetary outcomes? Public Choice, 136(1–2), 123–138.

    Article  Google Scholar 

  • Kumar, M. S., & Ter-Minassian, T. (2007). Promoting fiscal discipline. Washington: International Monetary Fund.

    Google Scholar 

  • Marneffe, W., Van Aarle, B., Van Der Wielen, W., & Vereeck, L. (2010). The impact of fiscal rules on public finances: Theory and empirical evidence for the euro area. CESifo Working Paper Series No. 3303.

  • Mellár, T. (2016). Szolgálólányból királycsináló—avagy az ökonometria mak-roökonómiai térhódítása? Közgazdasági Szemle, 63(3), 285–306.

    Article  Google Scholar 

  • Musgrave, R. A. (1959). The theory of public finance. New York: McGraw-Hill.

    Google Scholar 

  • Nerlich, C., & Reuter, W. H. (2013). The design of national fiscal frame-works and their budgetary impact. ECB Working Paper 1588.

  • Nickell, S. (1981). Biases in dynamic models with fixed effects. Econometrica, 49(6), 1417–1426.

    Article  Google Scholar 

  • Persson, T., & Svensson, L. E. O. (1989). Why a stubborn conservative would run a deficit: policy with time-inconsistent preferences. Quarterly Journal of Economics, 104(2), 325–345.

    Article  Google Scholar 

  • Poterba, J. M. (1996). Do budget rules work? NBER Working Paper No. 5550.

  • Reuter, W. H. (2015). National numerical fiscal rules: Not complied with, but still effective? European Journal of Political Economy, 39, 67–81.

    Article  Google Scholar 

  • Romer, C. (2012). Fiscal policy in the crisis: Lessons and policy implications. IMF Fiscal Forum, 1, 18.

    Google Scholar 

  • Sacchi, A., & Salotti, S. (2015). The impact of national fiscal rules on the stabilization function of fiscal policy. European Journal of Political Economy, 37, 1–20.

    Article  Google Scholar 

  • Szczypińska, A. (2014). Does the halo effect still hold? The (post-) crisis perspective for 4the euro candidates. IMF Working Paper Series, [number].

  • Thornton, J., & Vasilakis, C. (2017). The impact of fiscal rules on sovereign risk premia: International evidence. Finance Research Letters, 20, 63–67.

    Article  Google Scholar 

  • Tóth, G. Cs. (2010). Boosting demand by the state and automatic stabilizers. Public Finance Quarterly, 55(1), 51–70.

    Google Scholar 

  • Wyplosz, C. (2012). Fiscal rules: Theoretical issues and historical experiences. Working paper 17884 NBER.

Download references

Acknowledgements

The views expressed are those of the author and do not necessarily reflect the official view of the Central Bank of Hungary. The author uses the opportunity to express his thanks to János Ádám, Anna Adamecz, András Balatoni, István Benczes, Dávid Berta, Pál Czeglédi, László Jankovics, Tamás Jenei, Zalán Kocsis, László Muraközy, Judit Neményi, and Gábor Oblath for all their useful advice. The author is also grateful to the anonymous referees, whose comments on various drafts have substantially improved the paper. All errors are my own.

Author information

Authors and Affiliations

Authors

Corresponding author

Correspondence to Csaba G. Tóth.

Appendix

Appendix

See Appendix Fig. 7 and Tables 5, 6, 7, 8, 9 and 10.

Fig. 7
figure 7

Observations of a government with its own rules, with inherited rules and without any rules

Table 5 Descriptive statistics for the dataset
Table 6 Results of estimating regression Eq. (4) using GAP2 instead of GAP3. The GAP2 binary variable assumes a value of 1 if the output gap is positive and 0 otherwise
Table 7 Regression table of Eq. (3) using the dataset of observations with inherited rules (GOV = 2)
Table 8 Regression table of Eq. (4) with a new variable controlling for government ideology
Table 9 Regression table of Eq. (4) using the basic model (column 1) and the detailed model without the interaction (column 2)
Table 10 Regression table contains of Eq. (4) with the difference that the primary balance-to-GDP ratio was changed on both sides of the equation to cyclically adjusted primary balance-to-GDP ratio

Rights and permissions

Reprints and Permissions

About this article

Verify currency and authenticity via CrossMark

Cite this article

Tóth, C.G. Valuable legacy? The effect of inherited fiscal rules. Public Choice 178, 3–30 (2019). https://doi.org/10.1007/s11127-018-0605-6

Download citation

  • Received:

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11127-018-0605-6

Keywords

  • Fiscal policy
  • Fiscal rules
  • Fiscal discipline
  • Political economy

JEL Classification

  • H60
  • H62
  • E62