Effectiveness and counter‐cyclicality of fiscal consolidation under compliance regulation: The case of the Stability and Growth Pact

Abstract

AbstractIn this study we examine the impact of the European Stability and Growth Pact (SGP) on narratively identified fiscal adjustments whose prime focus is to reduce the budget deficit and compare the effects with those on the primary and the structural budget balance. The cross section of EU and non‐EU economies and the sample period 1980–2014 allow for an assessment of the SGP regarding its effectiveness, cyclicality, and the type of fiscal adjustments (tax hikes vs. spending cuts) as compared with counterfactual scenarios. Our findings indicate that the SGP has effectively boosted budget consolidation measures identified by means of the narrative approach, whereas it had no overall impact on the primary and an overall minor impact on the structural budget balance. However, the effectiveness of the SGP has varied considerably over time. All measures indicate that the SGP was particularly effective in the period after the introduction of the Euro, except for the 2 years following the financial crisis in 2008. We find no evidence that fiscal policy has become more procyclical under the SGP. Finally, fiscal consolidation under the SGP favors spending cuts, whereas the application of tax hikes shows no sizeable differences as compared with the reference group.