Stress testing the EU fiscal framework |
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Institution: | 1. University of Ljubljana, Faculty of Economics, Kardeljeva plo??ad 17, 1000 Ljubljana, Slovenia;2. Bank of Slovenia, Slovenska 35, 1505 Ljubljana, Slovenia;3. Juraj Dobrila University, Faculty of Economics and Tourism “Dr. Mijo Mirkovi?”, Preradovi?eva 1, 52100 Pula, Croatia;1. Banco de la República (Central Bank of Colombia), Carrera 7 #14-78, Bogotá, Colombia;2. Banco de la República (Central Bank of Colombia), Carrera 7 #14-78, Bogotá, Colombia;3. Tilburg University, The Netherlands;1. Department of Finance, Insurance and Real Estate, Faculty of Business Administration, Laval University, 2325, rue de la Terrasse, Pavillon Palasis-Prince, Quebec, Canada;2. Laboratory for Financial Engineering of Laval University, Department of Finance, Insurance and Real Estate, Faculty of Business Administration, Laval University, 2325, rue de la Terrasse, Pavillon Palasis-Prince, Quebec, Canada;3. IPAG Business School, Paris, France |
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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. |
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Keywords: | Cyclically-adjusted budget balance Structural deficit Fiscal policy EU fiscal governance SGP Great Recession DSGE Stress test |
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