Fiscal Rules and Structural Reforms

Implementation of fiscal surveillance rules relies heavily on the proper interpretation of legal terms, creating a need to infuse economic insight into legal analysis. Rigid legal application of fiscal deficit rules may curtail structural reforms, as reforms can go against fiscal consolidation in the short run. However, if reforms are expected to improve public finances in the long run, they should not be viewed as incompatible with the legal framework. Focussing on the case of EU fiscal surveillance, this paper identifies the circumstances under which the positive budgetary long-term effect of structural reforms materialize in such a way that the legal rules should be applied with a degree of leniency, allowing for a short-term deterioration of the fiscal position. To that end, we quantify the short-run fiscal costs and long-run fiscal benefits of reforms, and investigate how the design of reforms can affect this trade-off. Results suggest that as short run output losses of reforms are alleviated by fiscal stimulus, long run output gains from the reforms imply that fiscal viability can be reached within a reasonable period of time. Product market reforms are generally preferable over labour market reforms, as they have a larger impact on fiscal revenues. These insights inform the legal analysis in several regards. First, the economic analysis is in line with teleological interpretation of legal rules aimed at ensuring long-term fiscal stability, while allowing short-term fiscal leniency. Second, the economic analysis can give contours to vague legal terms, such as "prompt" positive budgetary effects and the legal requirement of "major" structural reforms, showing that the type of reform matters as much as the size of the reform, and that while larger reforms have larger long run budgetary effects, they also require greater leniency in the short run. More generally, our analysis calls for the design and interpretation of legal fiscal regimes with reference to the interdependency between fiscal policy and structural economic policies