Stable and enforceable: a new fiscal framework for the Euro area
04 Aug 2011-International Economics and Economic Policy (Springer-Verlag)-Vol. 8, Iss: 3, pp 225-245
TL;DR: In this paper, the authors consider an intertemporal assignment, where fiscal policy focuses on long-term objectives and monetary policy on short-term stabilisation, and argue for public sector debt targets as a practical way to achieve such a set up, and an excess debt protocol is constructed to give enforceable form to those targets.
Abstract: Since the great financial crash, the need for new fiscal rules to prevent unsustainable fiscal policies is universally recognised. In practice such rules, including those in the Stability and Growth Pact, have proved to be impossible to enforce. Thus, to avoid unsustainable fiscal policies reappearing, and to prevent monetary policy from being undermined by undisciplined governments, there is a need for a framework capable of imposing fiscal discipline. This paper considers an intertemporal assignment, where fiscal policy focuses on long-term objectives and monetary policy on short-term stabilisation. We argue for public sector debt targets as a practical way to achieve such a set up, and an excess debt protocol is constructed to give enforceable form to those targets. The ideas of “fiscal space” and optimal debt levels are used to provide a mechanism for identifying a stable region within which the debt targeting regime should operate. Making these factors explicit would both improve the credibility of planned fiscal policies and reduce risk premia on borrowing costs. We finally show how Europe’s competitiveness pact, and debt restructuring operations, can be used to maximise the available fiscal space.
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TL;DR: This article examined the consequences of the narrative construction of the group of countries that has been grouped as "PIIGS" (Portugal, Ireland, Italy, Greece and Spain) for their sovereign debt risk rating.
Abstract: This article analyses the consequences of the narrative construction of the group of countries that has been grouped as "PIIGS" (Portugal, Ireland, Italy, Greece and Spain) for their sovereign debt risk rating.Acronyms for groups of countries can provide a useful shorthand to capture emergent similarities in economic profile and prospects. But they can also lead to misleading narratives, since the grounds for use
of these terms as heuristic devices are usually not well elaborated. This article examines the process whereby the "PIIGS" group came into being, traces how Ireland became a member of this grouping, and assesses the merits of classifying these countries together. The contention is that the repetition of the acronym in public debate did indeed shape the behaviour of market actors toward these countries. It is argued that this involved a co-constituting process: similarities in market treatment drives PIIGS usage, which in turn promotes further similarities in market treatment. Evidence is found of Granger causality, such that increased media usage of the term "PIIGS" is followed by increased changes in Irish bond yields.
This demonstrates the constitutive role of perceptions and discourse in interpreting the significance of economic fundamentals.The use of acronyms as heuristics has potentially far-reaching consequences in the financial markets.
29 citations
TL;DR: In this article, a rule-based fiscal policy co-ordination to replace the failed Stability and Growth Pact in the euro area is considered, where a division of labour between fiscal and monetary policies is proposed, whereby fiscal policy is used for long-term targets and monetary policy for short-term stabilization.
Abstract: This contribution considers mechanisms for rule-based fiscal policy co-ordination to replace the failed Stability and Growth Pact in the euro area. It argues in favour of soft debt targets as a means of addressing problems caused by excessive debt. It is shown how such targets can be safely operated, supported by an effective excess debt protocol. A division of labour between fiscal and monetary policy is proposed, whereby fiscal policy is used for long-term targets and monetary policy for short-term stabilization. We then design a monitoring agency, in the form of a fiscal policy commission for Europe, to make the excess debt protocol operational. The contribution also addresses the issue of moral hazard, by proposing that governments be abandoned to financial markets at the upper debt limit, a commitment to be spelled out in advance. Finally, this framework is set within the idea of fiscal space. We show how structural reforms can expand that fiscal space.
28 citations
Additional excerpts
...NOTES 1 The early co-ordination literature identified comparative advantage in the use of policy instruments as the principle source of co-ordination gains (Currie et al. 1989; Hughes Hallett 1986)....
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...For a formal economic analysis of the fiscal space proposition, see Hughes Hallett and Jensen (2011)....
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...Biographical notes: Andrew Hughes Hallett is a Professor at George Mason University....
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...2 See, for example, Dixit and Lambertini (2003), Hughes Hallett and Weymark (2007) and Hughes Hallett (2008a,b)....
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...Addresses for correspondence: Andrew Hughes Hallett, School of Public Policy, George Mason University, Fairfax, VA 22030, USA. email: ahughesh@gmu.edu/Svend E. Hougaard Jensen, Department of Economics, Copenhagen Business School, Porcelaenshaven 16A, 2000 Frederiksberg C, Denmark. email: shj.eco@cbs.dk...
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TL;DR: In this paper, the authors examine the narrative construction of the group of countries that has been grouped as "PIIGS" (Portugal, Ireland, Italy, Greece, and Spain), and assess the merits of classifying these countries together.
Abstract: Acronyms for groups of countries provide an often useful shorthand to capture emergent similarities, and terms such as PIIGS, BRICs and LDCs pervade the lexicon of international and comparative political economy. But they can also lead to misleading narratives, since the grounds for use of these terms as heuristic devices are usually not well elaborated. This can become problematic when the use of such heuristics drives market responses in areas such as risk perception and changes in interest rates. In this paper we look at the narrative construction of the group of countries that has been grouped as ‘PIIGS’ (Portugal, Ireland, Italy, Greece, and Spain). We examine the process whereby the group came into being, trace how Ireland became a member of this grouping, and assess the merits of classifying these countries together. Our contention is that the repetition of the acronym in public debate shaped the behaviour of market actors toward these countries. We find evidence of Granger causality, such that increased media usage of the term ‘PIIGS’ is followed by converging interest rate correlations between Ireland and the other PIIGS, compared to the interest rate correlations between Ireland and the ‘northern’ Eurozone economies. We argue that this is a pointer toward the independent effect of perceptions and discourse over economic fundamentals. We conclude with more general thoughts and cautions on the use of heuristics in comparative political economy.
27 citations
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TL;DR: In this article, the authors examined the enforcement of the budgetary limits in the Stability and Growth Pact and found that enforcement was insufficient at the institutional level by the European Commission and by the Economic and Financial Affairs Council (ECOFIN).
Abstract: The Economic and Monetary Union in the European Union relies on fiscal coordination among member states to prevent excessive levels of deficit and debt and to ensure the stability of its single currency. This paper examines the framework of fiscal rules put in place before and after the launch of the euro. I find that enforcement of the budgetary limits in the Stability and Growth Pact was insufficient at the institutional level by the European Commission and by the Economic and Financial Affairs Council (ECOFIN), as well as at the level of the financial markets. In order for fiscal rules across the Eurozone to be successful, proposals for reforming the Pact, including the Six-Pack and the Fiscal Compact Treaty, will need to address enforcement problems on both political and market levels.
8 citations
Cites background from "Stable and enforceable: a new fisca..."
...Hallett and Jensen (2011) argue that fiscal targets should be long-term objectives, while the central bank should be involved with short-term stabilization....
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TL;DR: In this paper, the authors analyzed the issue of income convergence for Portugal, Italy, Ireland, Greece, and Spain towards France using non-stationary panel unit root tests both without as well as with structural breaks endogenously determined.
Abstract: The aim of this paper is to analyze the issue of income convergence for Portugal, Italy, Ireland, Greece, and Spain (PIIGS), towards France.The empirical analysis uses per capita GDP, in PPP and 2005 constant prices and covers the period from 1950 up to the recent pre-crisis year of 2009. The methodology applied uses non-stationary panel unit root tests both without as well as with structural breaks endogenously determined.The results clearly demonstrate the gain in power from combining structural breaks with panel data. Our findings provide evidence in favor of convergence for all the five countries with France.
7 citations
Cites background from "Stable and enforceable: a new fisca..."
...Academic usage of the term explodes in 2010, focusing upon the economic relationship of the PIIGS to the 2008 Euro crisis; where, PIIGS becomes synonymous with the countries involved in European debt crisis (Hallet and Jensen, 2011)....
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Abstract: How do governments react to the accumulation of debt? Do they take corrective measures, or do they let the debt grow? Whereas standard time series tests cannot reject a unit root in the U. S. debt-GDP ratio, this paper provides evidence of corrective action: the U. S. primary surplus is an increasing function of the debt-GDP ratio. The debt-GDP ratio displays mean-reversion if one controls for war-time spending and for cyclical fluctuations. The positive response of the primary surplus to changes in debt also shows that U. S. fiscal policy is satisfying an intertemporal budget constraint.
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TL;DR: In this article, the authors compare the costs and benefits of a common currency in the European Union and Latin America with respect to the Euro and the United Kingdom's transition to a monetary union.
Abstract: COSTS AND BENEFITS OF MONETARY UNION 1. The Costs of a Common Currency 2. The Theory of Optimum Currency Areas: A Critique 3. The Benefits of a Common Currency 4. Costs and Benefits Compared 5. Optimal Currency Areas Case Studies: Is the Enlarged European Union an Optimal Currency Area? Is Latin America an Optimal Currency Area? MONETARY UNION 6. Incomplete Monetary Unions: The European Monetary System, Dollarization 7. The Transition to a Monetary Union: Problems of Transition in Central Europe, Problems of Transition of the UK 8. The European Central Bank 9. Monetary Policy in Euroland 10. Fiscal Policies in Monetary Unions 11. The Euro and Financial Markets
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TL;DR: The authors studied how the composition of fiscal adjustments influenced their likelihood of "success" and their macroeconomic consequences, and found that fiscal adjustments that rely primarily on tax increases and cuts in public investment tend not to last and are contractionary.
Abstract: This paper studies how the composition of fiscal adjustments influences their likelihood of "success," defined as a long-lasting deficit reduction, and their macroeconomic consequences. We find that fiscal adjustments that rely primarily on spending cuts in transfers and the government wage bill have a better chance of success and are expansionary. On the contrary, fiscal adjustments that rely primarily on tax increases and cuts in public investment tend not to last and are contractionary. We discuss alternative explanations for these findings by studying a full sample of members of the Organization for Economic Cooperation and Development and by focusing on three case studies: Denmark, Ireland, and Italy.
533 citations
TL;DR: The authors analyzed the history of financial crises from England's fourteenth-century default to the current United States sub-prime financial crisis and found that serial default is a nearly universal phenomenon as countries struggle to transform themselves from emerging markets to advanced economies.
Abstract: This paper offers a "panoramic" analysis of the history of financial crises dating from England's fourteenth-century default to the current United States sub-prime financial crisis. Our study is based on a new dataset that spans all regions. It incorporates a number of important credit episodes seldom covered in the literature, including for example, defaults and restructurings in India and China. As the first paper employing this data, our aim is to illustrate some of the broad insights that can be gleaned from such a sweeping historical database. We find that serial default is a nearly universal phenomenon as countries struggle to transform themselves from emerging markets to advanced economies. Major default episodes are typically spaced some years (or decades) apart, creating an illusion that "this time is different" among policymakers and investors. A recent example of the "this time is different" syndrome is the false belief that domestic debt is a novel feature of the modern financial landscape. We also confirm that crises frequently emanate from the financial centers with transmission through interest rate shocks and commodity price collapses. Thus, the recent US sub-prime financial crisis is hardly unique. Our data also documents other crises that often accompany default: including inflation, exchange rate crashes, banking crises, and currency debasements.
466 citations
Posted Content•
TL;DR: The authors use a stochastic ability-to-pay model of sovereign default in which risk-neutral investors lend to a government that displays "fiscal fatigue," because its ability to increase primary balances cannot keep pace with rising debt.
Abstract: How high can public debt rise without compromising fiscal solvency? We answer this question using a stochastic ability-to-pay model of sovereign default in which risk-neutral investors lend to a government that displays "fiscal fatigue," because its ability to increase primary balances cannot keep pace with rising debt. As a result, the government faces an endogenous debt limit beyond which debt cannot be rolled-over. Using data for 23 advanced economies over 1970-2007, we find evidence of a fiscal reaction function with these features, and use it to compute "fiscal space," defined as the difference between projected debt ratios and debt limits.
408 citations