The Impact of Fiscal Rules on Public Debt and Public Deficits Based on the Budget Institutions Approach

Year 2024, Volume: 9 Issue: 1, 57 - 82, 30.06.2024

Ebru Yalçın , İlter Ünlükaplan

https://doi.org/10.30927/ijpf.1285953

Abstract

The budget institutions approach states that the differences between the public finance indicators of the countries are affected not only by economic conditions but also by institutional and political factors. Accordingly in order to prevent excessive public debt and public deficits, fiscal governance criteria must be established during the budget process.
In this paper, the impact of fiscal rules applied in 21 EU countries on public debts and public deficits was tested using the 1995-2016 period data by Westerlund and Edgerton (2007) panel cointegration method. Considering the Fiscal Rule Index (Eurostat 2019) for the design of fiscal rules, we show that well-designed rules reduce public deficits but have no statistically significant effect on public debt.

Keywords

Budget Institutions, Fiscal Governance, Fiscal Discipline, Fiscal Rule, Common Pool Problem

Project Number

SYL-2018-11282

The Impact of Fiscal Rules on Public Debt and Public Deficits Based on The Budget Institutions Approach

Abstract

The budget institutions approach states that the differences between the public finance indicators of the countries are affected not only by economic conditions but also by institutional and political factors. Accordingly in order to prevent excessive public debt and public deficits, fiscal governance criteria must be established during the budget process.
In this paper, the impact of fiscal rules applied in 21 EU countries on public debts and public deficits was tested using the 1995-2016 period data by Westerlund and Edgerton (2007) panel cointegration method. Considering the Fiscal Rule Index (Eurostat 2019) for the design of fiscal rules, we show that well-designed rules reduce public deficits but have no statistically significant effect on public debt.

Keywords

Budget Institutions, Fiscal Governance, Fiscal Discipline, Fiscal Rule, Common Pool Problem

Supporting Institution

Çukurova Üniversitesi BAP Koordinasyon Birimi

Project Number

SYL-2018-11282

References

• Acemoglu, D., Simon, J., James, R. & Yunyong, T. (2003). "Institutional Causes, Macroeconomic Symptoms: Volatility, Crises and Growth," Journal of Monetary Economics, Elsevier, 50(1): 49-123.
• Andrews, M. (2010). “Good Government Means Different Things in Different Countriesgove.” Governance: An International Journal of Policy, Administration, and Institutions, 23(1): 7–35.
• Alesina, A. & Perotti, R. (1996). “Fiscal Discipline and The Budget Process.” The American Economic Review, 86(2): 401-407. http://www.jstor.org/stable/2118160
• Alesina, A. & Tabellini, G. (1990). “A Positive Theory of Fiscal Deficits and Government Debt.” Review of Economic Studies, (57): 403-14. https://doi.org/10.2307/2298021
• Bali, B. B. & Çelen, M. (2007). Rule-Based Fiscal Policies and European Union Practice. Istanbul: Beta Press
• Breusch, T. S. & Pagan, A. (1980). “The Lagrange Multiplier Test and Its Applications to Model Specification in Econometrics.” The Review of Economic Studies, 47(1):239- 253.
• Buti, M. & Guidice, G. (2002). “Maastricht's Fiscal Rules at Ten: An Assessment.” Journal Of Common Market Studies, (40): 823-848.
• Caselli, F. & Reynaud, J. P. M. (2019). Do Fiscal Rules Cause Better Fiscal Balances? A New Instrumental Variable Strategy. IMF Working Paper No. 19/49, Available at SSRN: https://ssrn.com/abstract=3367434
• Commission of the European Communities. (2001). “European Governance A White Paper.” Brussels.
• Debrun, X. & Kumar, M.S. (2007). “Fiscal Rules, Fiscal Councils And All That: Commitment Devices, Signaling Tools Or Smokescreens?” Proceedings of Banca d’Italia Public Finace Workshop, Rome: Banca d’Italia, 479-512.
• Debrun, X. & Kumar, M.S. (2009). “The Discipline-Enhancing Role Of Fiscal Institutions: Theory And Empirical Evidence.” IMF Working Paper, No. 07/17, International Monetary Fund, Washington, D.C.
• Dziemianowicz, R. ( 2014). “Independent Fiscal Institutions as a Tool of Fiscal Governance” .Quarterly Journal of Economics and Economic Policy, 9(1): 59-70.
• Eberhardt, M. & Bond, S. (2009). “Cross-Section Dependence in Nonstationary Panel Models: A Novel Estimator.” MPRA Paper No. 17692, The Munich Personal RePEc Archive, Munich.
• European Commission. (2019). “Fiscal Rules Database.” Accessed May 14. https://economy-finance.ec.europa.eu/publications/fiscal-rules-database_en
• Friedman, M. & Friedman, R. (1980). Free to Choose. Houghton, Mifflin, Harcourt Publishing Company, Inc.
• Giosi, A., Testarmata, S., Brunelli, S. & Staglianò, B. (2014). “The Dimensions of Fiscal Governance as the Cornerstone of Public Finance Sustainability: A General Framework.” Journal Of Public Budgeting, Accounting & Financial Management, 26(1): 94-139.
• Haan, J., Jong-A-Pin, R. & O. Mierau, J. (2013). “Do Budgetary Institutions Mitigate the Common Pool Problem? New Empirical Evidence for the EU.” Public Choice 156(3-4):423–41. http://www.jstor.org/stable/42003168.
• Halleberg, M. & Hagen, J. (1999). “Electoral Institutions, Cabinet Negotiations and Budget Deficits in the European Union.” In University Of Chicago Press: Fiscal Institutions And Fiscal Performance, edited by James M. Poterba and Jürgen von Hagen, 209 – 232. University of Chicago Press, National Bureau of Economic Research.
• Hallerberg, M., Strauch, R. & Hagen, J. (2004). “The Design of Fiscal Rules and Forms of Governance in European Union Countries.” ECB Working Paper Series, No. 419, European Central Bank. Frankfurt, Germany.
• Hallerberg, M., Strauch, R. & Hagen, J. (2009). Fiscal governance in Europe. Cambridge University Press.
• Hemming, R. (2003). Policies to Promote Fiscal Discipline. IMF Fiscal Affairs Department, (2):1-19.
• IMF Database. (2019). “Gross Domestic Product.” Accessed May 18. https://www.imf.org/en/Data E
• International Monetary Fund. (2018a). How To Calibrate Fiscal Rules: A Primer. Washington, D.C.: International Monetary Fund.
• International Monetary Fund. (2018b). How To Select Fiscal Rules: A Primer. Washington, D.C.: International Monetary Fund.
• Kao, C. (1999). "Spurious Regression and Residual-Based Tests for Cointegration in Panel Data." Journal of Econometrics. (90): 1–44.
• Koçbulut, Ö. & Altıntaş, H. (2016). "Twin Deficits and the Feldstein-Horioka Hypothesis: The Analysis of Panel Cointegration with Structural Break Under The Cross Section Dependence on OECD Countries.” Erciyes University Journal of Faculty of Economics and Administrative Sciences, (48):145-174.
• Kopits, G.& Symansky, S.A. (1998). "Fiscal Policy Rules." IMF Occasional Paper, No. 162, International Monetary Fund. Washington, D.C.
• Menyah,K., Nazlioglu, Ş. & Wolde-Rufael, Y. (2014). "Financial Development, Trade Openness and Economic Growth in African Countries: New Insights from a Panel Causality Approach." Economic Modelling. (37): 386-394.
• Milesi-Ferretti, G. M. (2004). “Good, bad or ugly? On the effects of fiscal rules with creative accounting”. Journal of Public Economics, 88(1-2),377-394.
• OECD. (2013). “Fiscal sustainability”, in Government at a Glance 2013, OECD Publishing, Paris. DOI: https://doi.org/10.1787/gov_glance-2013-11-en
• OECD Data. (2019). “Public Deficit and Public Debt” Accessed May 14. https://data.oecd.org/
• Pedroni, P. (1999). “Critical Values for Cointegration Tests In Heterogeneous Panels with Multiple Regressors.” Oxford Bulletin of Economics and Statistics, 61(S1): 653-670.
• Pench, L., Ciobanu, S., Zogala, M., & Belu Manescu, C.. (2019). Beyond fiscal rules: How domestic fiscal frameworks can contribute to sound fiscal policy, VoxEU CEPR column.
• Perotti, R. & Kontopoulos, Y. (2002). "Fragmented Fiscal Policy." Journal of Public Economics, 86(2): 191-222.
• Pesaran, M. H. (2004). "General Diagnostic Tests for Cross Section Dependence in Panels." IZA Discussion Paper No: 1240, The Institute for the Study of Labor, Bonn.
• Pesaran, M. H. (2006). "A Simple Panel Unit Root Test in the Presence of Cross Section Dependence." Journal of Applied Econometrics, (22): 365-312
• Pesaran, M. H., Ullah, A. & Yamagata, T. (2008). “A Bias‐Adjusted LM Test of Error Cross‐ Section Independence.” The Econometrics Journal, 11(1):105-127.
• Pirdal, B. (2017). "A Comparative Analysis Of Fiscal Rules And Independent Fiscal Agencies," Journal of Afyon Kocatepe University Faculty of Economics and Administrative Sciences, 19(2), 1-12.
• Pirdal, B. (2018). "The Link Between Taxation and Fiscal Governance," Journal of Public Finance Studies, 4(2), 77-87.
• Polat, M. (2018). " The Effects of Exchange Rate Into Market Values of Companies: Coıntegration and Causality Analysis in OECD Countries.” Atatürk University Journal of Faculty of Economics and Administrative Sciences. 32(2): 211-230.
• Poterba, J. (1996). "Budget Institutions and Fiscal Policy in the U.S. States." Nber Working Paper Series, No.5449, National Bureau of Economic Research. Cambridge, MA.
• Raudla, R. (2010). “The Evolution of Budgetary Institutions in Estonia: A Path Full of Puzzles?” Governance: An International Journal of Policy, Administration, and Institutions, 23(3): 463–484.
• Roubini, N. & Sachs, J. D. (1989). "Political and Economic Determinants of Budget Deficits in The Industrial Democracies." European Economic Review. 33(5): 903-933.
• Songur, M. (2019). " The Validity of the Purchasing Power Parity Hypothesis Under Structural Breaks: The Case of Eurasian Countries." Bingöl University Journal of Social Sciences Institute, 9(17): 567-585. Songur Yaman, D. (2017). " The Effect of Foreign Direct Investments and Foreign Trade on Gross Domestic Product: The Case of the Eurasian Countries.” Bulletin Of Economic Theory and Analysis, 2(2): 117-133.
• Şaşmaz, M. U. & Sağdıç E. N. (2020). “The Effect of Government Effectiveness and Rule of Law on Economic Growth: The Case of European Union Transition Economies” Dokuz Eylül University Faculty of Business Journal, 21(1):203-2017.
• Ünlükaplan, İ. (2011). The Relationship between Fiscal Governance and the Performance of Public Finances in EU Member States. Ankara: Seçkin Press.
• Velasco, A. (1999). "A Model of Endogenous Fiscal Deficits and Delayed Fiscal Reforms." Fiscal Institutions and Fiscal Performance. National Bureau of Economic Research, Inc. 37-58.
• von Hagen, J. & Harden, I. (1994). “National Budget Processes and Fiscal Performance.” European Economy, Reports and Studies, No. 3, Economic and Financial Affairs . von Hagen, J. (1992). "Budgeting Procedures and Fiscal Performance in the European Communities." Economic Papers 96.
• Von Hagen, J. (1998). "Budgeting Institutions for Aggregate Fiscal Discipline." ZEI Working Papers, No. 01, 27-51, Center for European Integration Studies, Bonn.
• von Hagen, J. (2002). "Fiscal Rules, Fiscal Institutions and Fiscal Performance." The Economic And Social Review, 33(3), 263-284.
• Von Hagen, J. (2005). "Fiscal Rules and Fiscal Performance in the EU and Japan." CEPR Discussion Paper No. 5330, The Centre for Economic Policy Research, London. von Hagen, J. (2007). "Budgeting Institutions for Better Fiscal Performance." In Public Sector Governance and Accountability Series: Budgeting and Budgetary Institutions, edited by Anwar Shah, The World Bank Washington, D.C.
• von Hagen, J. (2012). "Common Pools: Why A European Fiscal Union Will Makes Things Worse?" The Bonn Journal of Economics, 1(1): 65-103 . Yıldırım, K., Mercan, M. & Kostakoğlu, F. S. (2013). " Test for Validity of Purchasing Power Parity: Time Series and Panel Data Analysis." Eskişehir Osmangazi University Journal of Faculty of Economics and Administrative Sciences, 8(3): 75-96.
• Westerlund, J. (2006). “Testing for Panel Cointegration with Multiple Structural Breaks.” Oxford Bulletin of Economics and Statistics, 68(1):101- 132. Westerlund, J. & Edgerton, D. (2007). "A Panel Bootstrap Cointegration Test." Economics Letters, 97(3): 185-190.
• Wildavsky, A. (1964). "The Politics Of The Budgetary Process." Toronto: Little, Brown And Co.
• Worlbank Data. 2019. “Openess.” Accessed May 18. https://data.worldbank.org/