The effects of fiscal institutions on fiscal adjustment

Abstract

Using a panel of 40 advanced economies over the period 1990–2020, this paper investigates the effect of various characteristics of fiscal institutions on the probability of starting a fiscal adjustment, as well as on the probability that this fiscal adjustment will be successful. We find that, an enriched and cleverly designed fiscal rule which incorporates both strict and flexible features increase both the probability to initiate and to successfully conclude a fiscal adjustment. The design features that are associated with stricter fiscal rules lead to a more pronounced increase in the probability of success vis-à-vis features that allow some flexibility e.g., by taking into account cyclical economic conditions. A fiscal council with enhanced powers which involve enhanced remit, independence and accountability and enhanced tasks & instruments increase the probability to initiate a fiscal adjustment. However, it is primarily fiscal councils with enhanced tasks & instruments that can lead to a successful fiscal adjustment. The results remain valid after conducting several robustness checks. Our findings contribute to the on-going debate on the revision of the EU fiscal framework and the importance it should be assigned to improved fiscal rules and national fiscal councils.