Multilevel governance in fiscal consolidation and stabilisation

1. Multilevel governance in fiscal consolidation and stabilisation Waltraud Schelkle (w.schelkle@lse.ac.uk) Deborah Mabbett (d.mabbett@bbk.ac.uk) Practitioners’ Forum , 30-31 March 2006, LSE: ‘Policy learning and experimentation in EU economic governance’

2. Overview • What comparative fiscal federalism tells us and misses.. • What the empirical data show us.. • How great is the need for differential fiscal responses? • How adequate are member states’ responses? • Do the responses add up to a consistent fiscal policy for EMU? • How our findings differ from received wisdom.. Practitioners' Forum on policy learning and experimentation in EU economic governance

3. What comparative fiscal federalism tells us.. Agents in fiscal federations have little incentive to keep financial discipline (eg von Hagen et al 2001) • Implicit bail-out guarantee of a political union • Incentives for tax competition and more debt finance in a monetary union Therefore, fiscal discipline has to be imposed by balanced budget rules (SGP); But these may produce pro-cyclical fiscal policy (Hallerberg and von Hagen 1999). Practitioners' Forum on policy learning and experimentation in EU economic governance

4. What comparative fiscal federalism misses.. • Little incentive for free-riding due to lack of fiscal transfers and an explicit no bail-out clause. • Agents, ie the member states, have signed themselves up to fiscal discipline. Instead, problems may arise because constraints on agents/MS are not matched by collective risk pooling (Schelkle 2005). Practitioners' Forum on policy learning and experimentation in EU economic governance

5. What the empirical data shows us (1).. How much need is there for a differential response of macroeconomic policies? • Required interest rates according to Taylor rule (cf. Gramlich and Wood 2000) i* = r* + 0.5(output gap + excess inflation) r* = 2% Output gap = Actual minus trend GDP in percent of GDP at 1995 market prices Excess inflation = inflation rate above 1.5% Practitioners' Forum on policy learning and experimentation in EU economic governance

6. Need for a differential response of macroeconomic policy (1)? Practitioners' Forum on policy learning and experimentation in EU economic governance

7. Need for a differential response of macroeconomic policy (2)? Practitioners' Forum on policy learning and experimentation in EU economic governance

8. What the empirical data shows us (2).. How well did member states’ fiscal policies respond? • Correlation between changes in budget deficits and changes in output gaps (cf. Gramlich and Wood 2000): • Actual deficits: Pro- or countercyclical? • Structural deficits: Discretionary stance? • Volatility of GDP and budget responses: Fiscal activism up or down? Practitioners' Forum on policy learning and experimentation in EU economic governance

9. Actual deficits: counter-cyclical (positive correlations)? Practitioners' Forum on policy learning and experimentation in EU economic governance

10. Structural deficits: counter-cyclical (1)? Practitioners' Forum on policy learning and experimentation in EU economic governance

11. Structural deficits excluding interest: counter-cyclical (2)? Practitioners' Forum on policy learning and experimentation in EU economic governance

12. Fiscal activism: Paralysed or adequate? Practitioners' Forum on policy learning and experimentation in EU economic governance

13. What the empirical data shows us (3).. Do member states’ responses add up to the right policy mix and an appropriate aggregate fiscal stance? • Policy mix: Taylor rule for the Euro area and actual ECB interest rates. • Aggregate fiscal stance: sum of actual and structural deficits. Practitioners' Forum on policy learning and experimentation in EU economic governance

14. The policy mix for EMU Practitioners' Forum on policy learning and experimentation in EU economic governance

15. Aggregate fiscal stance Practitioners' Forum on policy learning and experimentation in EU economic governance

16. How our findings differ from received wisdom (1).. The sub-central (MS) level is less of a problem. • Fiscal discipline of MS does not appear to have deteriorated. • Stabilisation policies of MS have, if anything, improved. • Asymmetries seem to have become smaller (supported by recent findings on the synchronisation of business cycles). Practitioners' Forum on policy learning and experimentation in EU economic governance

17. How our findings differ from received wisdom (2).. But the central (EMU) level is not fulfilling its function. • Monetary policy seems to be too tight. • The aggregate fiscal stance hardly moves with the Euro area output gap. • The aggregate fiscal stance provides little stimulus. Practitioners' Forum on policy learning and experimentation in EU economic governance

18. Conclusion (1) • Research focus in fiscal federalism has been on the agents’ incentives and how they can be constrained. • An alternative interpretation of the governance framework is that national governments have sought to get better control over their domestic fiscal policies, using EMU as a lever (laboratory federalism). • We find signs of success with this. Practitioners' Forum on policy learning and experimentation in EU economic governance

19. Conclusion (2) • But the governance framework does not provide for adjusting the aggregate fiscal position in the light of the required macroeconomic stance. • This omission becomes a more pressing issue with the vanishing of asymmetries and the synchronisation of cycles. Practitioners' Forum on policy learning and experimentation in EU economic governance