FISCAL RETRENCHMENT IN ESTONIA DURING THE FINANCIAL CRISIS: THE ROLE OF INSTITUTIONAL FACTORS

Abstract

Unlike most other countries in Europe, which engaged in expansionary fiscal policies in 2009, the government of Estonia followed the opposite path by adopting several austerity packages, combining expenditure cuts and tax increases. This paper explores whether (and to what extent) the theoretical propositions from the literature on political economy of fiscal adjustment that focus on institutional factors are able to explain how it was possible to undertake such extensive fiscal adjustment in Estonia. The case study shows, first, that a coalition government and a minority government are able to achieve fiscal adjustments, especially if there is political commitment to lower the deficit. Second, the study indicates that an externally imposed fiscal rule can act as a major focal point in guiding deficit‐reduction efforts. Third, the Estonian case demonstrates that centralised budgetary institutions are conducive to fiscal adjustment and mitigate the problems arising from size fragmentation.