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Graduate Institute of International Studies, Geneva; BRUEGEL, Brussels; Currently on leave from IMF Fiscal AffairsDepartment. Corresponding address: 11 A, Avenue de la Paix, CH-1202, Genève, Switzerland. Email: firstname.lastname@example.org. Tel: +41-22-908-5928.
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We are grateful to the European Commission, and in particular Servaas Deroose, Elena Flores, Laurent Moulin and Alessandro Turrini for sharing data on fiscal rules and institutions. We would also like to thank Teresa Ter-Minassian, Director of the IMF Fiscal Affairs Department, for her support and helpful comments and suggestions, as well as Anthony Annett, Joaquim Ayuso, Helge Berger, Signe Krogstrup, Carlos Martinez-Mongay, and seminar participants at the Graduate Institute of International Studies in Geneva and the Free University of Berlin for useful comments on a first draft. Annette Kyobe provided research assistance, and Anthony Annett helped us with data.
In McCallum’s words, institutions per se do not “overcome the motivation” for biased policies but “merely relocate it.”
Cukierman (2002) discusses the relationship between accountability and transparency in central banking.
Examples include Tabellini and Alesina (1990), Beetsma and Bovenberg (1997), Peletier, Dur, and Swank (1999), Debrun (2000), Dixit and Lambertini (2003), Manasse (2005), Beetsma and Debrun (2007), and Krogstrup and Wyplosz (2006).
In the context of monetary policy delegation, Jensen (1997) overcomes the McCallum critique by introducing exogenous costs to reappoint a new central banker.
Randomizing period 2 income only complicates the notation without bringing additional insight to the analysis.
The assumption of an under-informed public is fairly common in theoretical analyses of fiscal bias. See Morris, Ongena, and Schuknecht (2006) for a survey.
The second-order condition is satisfied by concavity of v(⋅).
One way to interpret this is that governments facing severe resource constraints may need strict conditionality attached to an IMF-supported program to avoid a deficit bias, while richer governments may rely on possibly less demanding domestic arrangements.
In the monetary sphere, McCallum (1995) notes the absence of a constitutional amendment abolishing the metallic standard in the United States.
This of course requires that voters do not suffer from a myopic appetite for fiscal deficits—or “fiscal illusion.” Calmfors (2005) and Morris, Ongena, and Schuknecht (2006) discuss fiscal illusion in detail.
In a model of monetary policy delegation, Jensen (1997) argues that reneging on central bank independence causes reputation losses, which can help sustain near-optimal institutions in a repeated game. In our three-period setup, however, repeated games become quite cumbersome and it is more convenient to think in terms of political costs associated with either a change in institutions or an attempt to bypass them. Another well-known shortcoming of repeated games is the multiplicity of reputational equilibria, reflecting the arbitrary definition of the “trigger strategies.”
Observe also that in this instance, rewarding compliance with the fiscal rule is a socially optimal voting strategy for voters.
See Castellani (2002) for a formal analysis of accountability and transparency along similar lines in a model of monetary policy delegation.
Recall that competence is only an issue for the under-informed voters. In reality, neither high deficits nor large policy failures originate in a lack of competence.
A negative value for the delivery shock is possible from the voters’ perspective because they do not know the true distribution. Of course, δ− could be strictly positive if individuals had a profound distrust of policymakers’ capacity to efficiently deliver public goods. For the sake of brevity, we do not explicitly analyze this issue here.
See Rogoff (1990) although here the argument is related specifically to a lack of transparency, rather than information asymmetry per se.
The possible endogeneity of institutions is a general concern in empirical analyses of the link between the latter and economic performance. The main problem is that a similar set of “deep” determinants may simulatenously affect institutions and performance (see for instance Acemoglu, Johnson and Robinson, 2001, or Funk and Gathmann, 2005).
The “change” or the “event” is predetermined as an increase in the index of fiscal restrictiveness of at least 10 percent. Alternative larger cut offs reduced the sample size somewhat but did not lead to an appreciable change in the conclusions.
Similar results were obtained for the cyclically-adjusted primary balance.
Using mean rather than median provides similar results.
Given that there has been relatively much less change in the role played by fiscal agencies, the above analysis was confined to the restrictiveness and coverage of fiscal rules.
The EU-15 minus Luxembourg, plus Australia, Canada, Switzerland, and the U.S.
The government stability variable is an index ranging from 0 to 12, with the highest figure indicating perfect stability. The index is taken from the International Country Risk Guide (ICRG), compiled by the PRS Group, a consultancy. Other political variables have been constructed using the World Bank’s Database on Political Institutions.
These dummies proved highly insignificant when included in the model.
One reason for such correlation is the possibility of time-invariant factors affecting the capacity or willingness to generate high primary surpluses in each country. Another reason is the possible persistence in the idiosyncratic shocks to primary surplus behavior. See Celasun, Debrun, and Ostry (2006) for a detailed discussion of the statistical biases related to the estimation of fiscal reaction functions, and Celasun and Kang (2006) for a technical discussion of alternative estimators.
If ψ = 1/2, then δ1 is not a signal of competence, and zQ,0 = zQ,1, Q = C, L irrespective of δ1. In that case, the incumbent government is assured to be re-elected, and the analysis of the political equilibrium loses any interest.