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Title:A fiscal rule that has teeth : a suggestion for a "fiscal sustainability council" underpinned by the financial markets PDF Logo
Authors:Hedbavny, Petr
Schneider, Ondřej
Zapal, Jan
Issue Date:2005
Series/Report no.:CESifo working papers 1499
Abstract:In this paper, we set out to examine an efficient fiscal-policy framework for a monetary union. We illustrate that fiscal policy?s bias toward budget deficit only temporarily ceased at the end of the 20th century as European countries endeavored to qualify for euro-zone membership, which compelled strict limits on budgetary deficits. We then explore which mechanisms might instill a sense of fiscal disciple in governments. We find that most mechanisms suffer from the incentive-incompatible setup whereby governments restrict their own fiscal-policy freedom. We argue that even multilateral fiscal rules, such as the EU?s Stability and Growth Pact, suffer from the same endogeneity flaw. Consequently, we argue that a fiscal rule must incorporate an external authority that would impartially assess fiscal-policy developments. Using U.S. debt and bond-market data at the state level, we show that financial markets represent a good candidate as, vis-?-vis the American states, they do differentiate state debt according to the level of debt. We thus argue for a fiscal institution??what we call the Fiscal Sustainability Council??that would actively bring financial markets into the fiscal-policy process, and we explain the technique whereby this could be effected.
Subjects:fiscal policy
European Union
sustainability
JEL:H6
H87
E6
Document Type:Working Paper
Appears in Collections:CESifo Working Papers, CESifo Group Munich

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