Discretionary Fiscal Policy in the EMU Context: An Empirical Approach (1981-2010) and the Recent Reform of European Governance

By Solomos, Dionysios K.; Koumparoulis, Dimitrios N. | European Research Studies, April 2012 | Go to article overview

Discretionary Fiscal Policy in the EMU Context: An Empirical Approach (1981-2010) and the Recent Reform of European Governance


Solomos, Dionysios K., Koumparoulis, Dimitrios N., European Research Studies


1. Introduction

The debt crisis in the Eurozone (EZ) is one of the most crucial challenges in modern economic history. The decline of public finances of many member states constitutes an explosive mixture that threatens the existence of the Eurozone itself and has significant impacts for the global economy. As the leadership of EU is still searching for solutions and actions which will counteract the problem and restore the stability, the analysis of the causes which led to the systemic crisis, the examination of the institutional framework of European governance and the evaluation of the measures and policies adopted, are considered as matters of great importance which require extensive analysis and critical approach. The current paper attempts to approach these aspects from the perspective of fiscal policy, examining them from both a theoretical and empirical background.

Membership in the Eurozone implies that apart from the delegation of monetary policy to the conservative European Central Bank (ECB), there are obligations and restrictions on fiscal policy for the member states. Even though the latter remains a political tool into the hands of national authorities, they must comply with the rules set at EU level in order the stability to be achieved. The implementation of sound and disciplined fiscal policies and the coordination of them in central level are key elements for ensuring the financial stability in the eurosystem.

As the project of European integration was not associated with a fiscal union, the member states have maintained the independence of their national fiscal policies. However, their autonomy is limited significantly by the existence of the euro zone's supranational fiscal rule. The Stability and Growth Pact (SGP) offers guidance and coordinates the implementation of fiscal policy through the obligation of member states to respect the rules and the procedures that the Pact predicts. The target of the SGP is to perform effectively a dual function: to ensure the sustainability of public finances prompting the governments to run sound policies and to provide the necessary flexibility so as the national authorities to be able to deal with the negative fluctuations of the business cycle.

This paper consists of two parts. In the first section, we are trying to acknowledge the particular structure of fiscal policy in EMU context. We examine empirically how the restrictions of Maastricht criteria and the SGP have impaired the capacity of national authorities to run countercyclical discretionary fiscal policies and whether the stabilization function of fiscal policy is associated with less procyclical discretionary policies. The division of the EZ countries into two subgroups (north--south) will provide us useful conclusions about the different effects the constraints have had on rich north and poor south. Lastly, we will evaluate whether the national fiscal rules can counteract political indiscipline and their efficiency on budget outcomes.

In the second section, we will approach the recent reform of the European governance, providing details of the reform package and discussing its appropriateness and its potential effectiveness on the restore of the European financial stability.

2. Discretionary Fiscal Policy in the EMU: An Empirical Approach

The main objective of the empirical analysis is to examine to what extent the constraints of both Maastricht criteria and SGP have affected the way national authorities conduct their discretionary fiscal policy. Provided that the monetary policy of all countries in the Eurozone is managed by the ECB, the fiscal policy undertakes the responsibility to operate as a stabilizing tool of the business cycle and to counteract the negative asymmetric shocks. Consequently, it is the foremost tool in the quiver of governments to deal with their country-specific fluctuations. For this reason, we would expect that the process of European integration should be linked to the adoption by the member-states of more countercyclical discretionary fiscal policies. …

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