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One Size Fits None - Achieving Fiscal Discipline in the Aftermath of the Euro Crisis

European Union
Policy Analysis
Political Economy
Euro
Michael Herman
Tampere University
Michael Herman
Tampere University

Abstract

How can fiscal discipline in a monetary union be achieved? The question is of particular relevance in light of the explosion of public debt that occurred in the aftermath of the financial crisis in the US after 2008 and in the Economic and Monetary Union’s (EMU) after 2010. Reforms to the EU’s chosen fiscal framework, the Stability and Growth Pact (SGP) have shifted the balance of power from national governments to the supranational level in matters of fiscal policy. This development raises the question: should fiscal policies in the EU be subject to centralised control? This is an interesting research question because the empirical evidence correlating good fiscal performance to centralized institutional arrangements is mixed. Von Hagen (2002), using panel evidence from 12 European countries found that centralised budget processes lead to lower government deficits and debt. This was also the conclusion drawn by Stein et al (1999), who studied fiscal performance in Latin countries. Wyplosz (2015), meanwhile, has argued in the EU context that the SGP has not resulted in fiscal discipline because centralised fiscal frameworks impose an external constraint on member states. Such a constraint, he argues, is incompatible with budgetary sovereignty, which was established as a fundamental principle in the Maastricht Treaty. The paper draws on theories of multilevel governance and fiscal federalism. These twin literatures explore the inter-relationships between different levels of government. The theories lay out a normative framework for the assignment of functions to different levels of government and the appropriate fiscal instruments for carrying out state functions. The paper builds on this argument and empirically test its validity through longitudinal and cross sectional case studies of fiscal performance in different institutional settings. The study advances two hypotheses: 1. Self-imposed constraints (i.e., rules) are more likely to deliver fiscal discipline than external injunctions. 2. Public sector risk can be reduced if central monetary authorities are granted regulatory authority over private banking institutions and empowered to act as lender of last resort. The hypotheses are tested by examining fiscal outcomes in two comparative cases. To test H1, longitudinal sub-national fiscal data from two disparate federal systems are analysed: the United States (US) and Germany. To test H2, cross-sectional fiscal data from Nevada and Ireland are examined. The analysis of empirical data suggests that internal institutions rather than external constraints are more conducive to fostering fiscal discipline and that supranational banking sector oversight is more conducive to macroeconomic stability than national supervision.