Cyclical and Structural Deficits on the Road to Accession: Fiscal Rules for an Enlarged European Union

The Paper is one of the first attempts to compute cyclical and structural deficits for a set of countries candidate to accession to the EU. Three main results are derived: first, the high deficits observed in candidate countries in recent years have a structural nature. Second, the fiscal stance has been pro-cyclical in candidate countries. Finally, because of higher volatility of output in these countries, the risks of surpassing the 3% budget limit that applies to all members of the EU are much higher for them. Without changing existing rules in the European Union, it is likely that candidate countries will have to undertake costly and inefficient adjustments of the last minute. Recent proposals by the European Commission would improve matters for candidate countries, without however solving some of their major potential difficulties. The Paper suggests a new fiscal rule for an enlarged European Union, which is consistent with the philosophy of the Stability and growth Pact but focuses on ex ante limits to expenditure. Such a rule would imply that in periods of growth above trend, countries are forced to run budget surplus, while in periods of economic slack they will run deficits. The rule is fully consistent with the theory of optimal tax smoothing and would, at the same time, strengthen fiscal discipline.