Reconciling Fiscal Ceilings with Macro Stabilization

• Authors: Geert Mesters.
• BSE Working Paper: 112276 | July 21
• Keywords: forecasting , impulse responses , fiscal rules , stability and growth pact
• JEL codes: E32, E62
• forecasting
• impulse responses
• fiscal rules
• stability and growth pact

Fiscal rules are widely used to constrain policy decisions and promote fiscal discipline,but the design of flexible yet effective rules has proved a formidable task. In practice,fiscal rules take the form of fiscal ceilings —hard thresholds on fiscal variables— which have the benefit of simplicity but are rigid and frequently violated. In this paper, we show that there exists a class of fiscal rules —fiscal-macro targeting rules— that can simultaneously flexibilize fiscal ceilings —leave more room for macro stabilization—and increase overall fiscal discipline. Fiscal-macro targeting rules nest fiscal ceilings asa special case and offer the same benefits: they are simple, transparent, easy to monitor and can be set without reference to a specific model. We illustrate the workings of fiscal-macro targeting in the context of the EU Stability and Growth Pact.