Fiscal policy and monetary integration in Europe: an update

Abstract

By distinguishing between discretionary and non-discretionary fiscal policy, this paper analyses the stability of fiscal rules for EMU countries before and after the Maastricht Treaty. Using both Instrumental Variables and GMM techniques, it turns out that discretionary fiscal policy has remained procyclical after 1992. This result contradicts the previous findings of Galí and Perotti. It also appears that fiscal rules differ between large and small countries; large countries follow a procyclical discretionary policy. Furthermore, the paper shows that discretionary fiscal policy exhibits different behaviour when facing supply or demand constraints. A procyclical discretionary policy is followed mainly during upswings, when supply constraints are prevalent. Finally, there is no support for the presence of a ‘fatigue effect’ in fiscal discipline.