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Do fiscal rules constrain political budget cycles?

Date:30 May 2019
Author:Bram Gootjes, Jakob de Haan and Richard Jong-A-Pin
Political budget cycles only occur in countries with weak fiscal rules, or in countries with no fiscal rule at all.
Political budget cycles only occur in countries with weak fiscal rules, or in countries with no fiscal rule at all.

One of the main premises in the study of Public Choice is that politicians may serve other interests than the general interest. A prime example is the phenomenon that incumbent governments adopt expansionary fiscal policy in election years to increase their chances of re-election. The cycles in government spending, taxation, and budget deficits as a consequence of opportunistic political behavior are known as “political budget cycles ” (PBC’s). However, the use of fiscal policy to “buy” votes  is often inefficient and can be harmful for the economy, in particular when the economy would benefit from counter-cyclical policy.

In recent years, the focus of the research on political budget cycles has shifted from the question whether PBC’s occur towards the question under which circumstances do PBC’s occur. Even though this literature on so-called conditional political budget cycles is flourishing, till date no study has investigated the constraining impact of fiscal rules on the occurrence of PBC’s. This is rather surprising because fiscal rules are created to constrain fiscal policy through numerical aggregates.

Fiscal rules can be implemented in different forms. The Netherlands, for example, have installed expenditure rules, revenue rules, and balanced budget rules on a national level. Furthermore, since the Netherlands are a member of the European Economic and Monetary Union (EMU), it faces also the fiscal rules that are part of the Stability and Growth Pact. On the other hand, countries like Switzerland and Norway (both not part of EMU) only have installed national balanced budget rules, whereas countries like Canada or Turkey do not use fiscal rules.

In a recent Working Paper of De Nederlandsche Bank (Gootjes, de Haan and Jong-A-Pin, 2019), we have studied the moderating role of fiscal rules in the relationship between elections and expansionary fiscal policies. We examined whether fiscal rules are an effective tool to constrain opportunistic political behavior in election times. In our study we use data for 77 (advanced and developing) democracies over the 1984-2015 and a new database on fiscal rules from the International Monetary Fund. We find that political budget cycles only occur in countries with weak fiscal rules or in countries with no fiscal rule at all. Hence, fiscal rules efficiently restrain politicians not to overspend in election years and once they become sufficiently strong, we do not see a significant impact of elections on the government budget. Our findings are remarkably robust if we control for other dominant explanations why PBC’s occur such as the degree of media freedom in a country.   

The evidence we report in our paper holds primarily for the period after the global financial crisis of 2007-2008. In the aftermath of the global financial crisis, public finances deteriorated in most countries and fiscal variables more often reached or even surpassed the budgetary limits laid down in the fiscal rules. As a consequence, many countries responded by strengthening their fiscal frameworks and adopted more fiscal rules. We find that prior to the global financial crisis, fiscal rules do not seem to dampen political budget cycles, but after the crisis fiscal rules strongly affect the opportunistic behaviour of incumbent governments in election years. We think that a strengthening of the fiscal frameworks after the crisis and the fact that fiscal rules started to ‘bite’ more often lowered the room for fiscal maneuver for electoral purposes.

Further reading:

Gootjes, B., de Haan, J. and Jong-A-Pin, R. (2019). Do fiscal rules constrain political budget cycles? DNB Working Paper, no 634 / May 2019. De Nederlandsche Bank.