The Effect of Inherited Fiscal Rules

Many budgeting scholars are currently interested in whether a rule-based system could be used for improving fiscal sustainability. In the US, congress’s own dismissive treatment of the rules governing the budget process are supportive anecdotes of the view that self-imposed rules do not bind. Furthermore, there is little doubt that adopting rules (e.g. like Balanced Budget Amendments) is at least partially just signalling what you intend to do regardless of the rules. Nevertheless you’d expect that it is possible to raise the political cost of certain actions.

In this spirit is an interesting article forthcoming in Public Choice by Csaba Toth (Central Bank of Hugary) on “Valuable Legacy? The Effect of Inherited Fiscal Rules.” Here is the abstract:

The working mechanism of national fiscal rules depends strongly on whether a government must comply with its own rules or inherited ones. In the former case, a government usually introduces fiscal rules to show its commitment to a disciplined fiscal policy (the signaling function). In the latter context, however, inherited rules constitute external obstacles to budgetary policymaking (the limiting function). This study mainly is concerned with the limiting function and therefore bases its empirical analysis on periods when the ruling government inherited fiscal rules introduced by a previous government. The results of a panel-data econometric study indicate that national fiscal rules do contribute to disciplined fiscal policy after a change in government in times of an economic upturn. That finding, however, does not mean that the signaling function is ineffective: quite the contrary. My results, in line with the literature, indicate that the double functions of rules may complement one another. A government that introduces such rules is often already committed to a disciplined policy and wishes to signal such commitment in the short term. With the appearance of new government, however, the function of rules changes, and they efficiently promote disciplined fiscal policy in the long term.

That abstract is a nice summary of the paper’s main points. The empirical work is based on 27 EU members states from 1995 to 2008. Section 3 (Databases and New Methods) is a section not to be skipped, and it is a credit to the author that such a detailed description of where the reader might want to be skeptical of the data’s coding and other limitations. For instance, this has the potential to be a big drawback.

Before delving into the details, however, I need to emphasize that my definition of budgetary rules is limited in several ways. On the one hand, this study concerns only the numerical values of the procedural rules in effect during the compilation and enforcement of the general public budget. In doing so, I concentrate exclusively on the rules contained in national legal systems and thus ignore supranational provisions. Third, budget rules are in place worldwide; this study focuses on European practice and more precisely on the EU member states.

It is an impressive paper, and if you teach a doctoral level course on budgeting it is worth consideration for syllabus space.

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