Fiscal policy in EMU : rules, discretion and political incentives

The present paper provides a broad review of these issues, based on findings in the literature and our own recent analytical work. Section 2 presents a bird's eye view of the history of the downfall of fiscal discretion in favour of fiscal rules and how this has shaped fiscal coordination in EMU. Section 3 develops a broader view on automatic stabilisers, including supply side aspects that affect their stabilisation properties in the face of asymmetric shocks. The latter cannot be dealt with by a one-size-fits-all monetary policy, so automatic stabilisers are essential and we draw conclusions on how automatic stabilisers could be strengthened in this regard. Section 4 examines to what extent political incentives have affected fiscal behaviour in EMU to date and how these incentives could be stemmed in the future. Section 5 concludes. The fiscal philosophy of EMU's budgetary rules is to bring deficits close to balance and then let automatic stabilisers play freely. Given the large tax and benefit systems in Europe, relying mainly on automatic stabilisation would allow a relatively high degree of cyclical smoothing while avoiding the typical pitfalls of fiscal activism.