Fiscal policy in Europe and the stability and growth pact

Abstract

The paper investigates how European fiscal authorities behaved in the last decades - namely, und er the constraint posited by the European Monetary Systems during the I 980s, the Maastricht Treaty during the 1990s, and the Stability and Growth Pact (SGP) later on - also taking into account monetary and fiscal policy interactions. We argue that the traditional measure used for evaluating fiscal policy - the cyclically-adjusted public budget (CAPB) - is a too rough indicator of the fiscal stance as a function of the two objectives of output stabilization and debt decumulation. We construct two theoretical appraisals of the fiscal rule pursued by the government - Tax Smoothing and Expenditure Smoothing-and use them as dependent variables in our econometric estimates. Under quite plausible conditions, the compliance with the 3% limit on the public deficit / GOP ratio imposed by the SGP could imply the renounce during a downswing, not only to pursue discretionary fiscal policy but also to output stabilization by a utomatic stabilizers. We conclude that fiscal s ustainability - that is the compliance with the intertemporal public budget constraint which is required to the fiscal authorities of the European Monetary Union (EMU) - stresses the objective of debtdecumulation, thus creating a trade-off with the objective of output stabilization, especially for the high-debt EMU countries.