Fiscal Rules and Fiscal Performance in the EU and Japan

Fiscal rules specify quantitative targets for key budgetary aggregates. In this paper, we review the experience with such rules in Japan and in the EU. Comparing the performance of fiscal policy in the 1980s and 1990s until 2003, we find that the fiscal rule of the 1980s exerted some but not much disciplinary influence on Japanese fiscal policy. The fiscal rule of the Maastricht Treaty had a significant impact on political budget cycles in the EU, but did little to constrain fiscal policy in the large member states. Since the start of the European Monetary Union, the disciplinary effect of the fiscal rule in the EU has vanished. Next, we discuss the importance of budgetary institutions for the effectiveness of fiscal rules. In Europe, a number of countries adopted strong fiscal rules, i.e., a fiscal rule combined with a design of the budget process enabling governments to commit to the rule. We find that strong fiscal rules have been effective. We conclude with some suggestions for the design of a strong fiscal rule in Japan

Fiscal policy and intranational risk-sharing

A general feature of national fiscal systems is that they provide buffers against regional fluctuations in output and employment by redistributing income between the different regions of a country. Recent literature in connection with European monetary integration has stressed the insurance aspect of this function: Through the fiscal system, regions obtain insurance against asymmetric shocks. In this paper, we review the literature on risk-sharing through fiscal mechanisms. While consumption smoothing would call for full risk-sharing among regions, moral hazard problems, political economy problems and considerations of macro economic stabilization reduce the optimal degree of risk sharing. This may explain why empirical research generally finds that intranational risk-sharing based on fiscal policy seems rather modest. --

Political Economy of Fiscal Institutions

We discuss two essential problems of the political economy of public finances: The principal agent problem between voters and elected politicians and the common pool problem arising from the fact that money drawn from a general tax fund is used to pay for policies targeting more or less narrow groups in society. Three institutional mechanisms exist to deal with these problems, ex-ante rules controlling the behavior of elected policy makers, electoral rules creating accountability of and competition among policy makers, and budgeting processes internalizing the common pool externality. We review recent theoretical and empirical research and discuss its implications for research and institutional design.electoral systems; fiscal rules; budgeting processes

Money Growth Targeting

The recent debate over monetary policy strategies concludes that monetary targeting and inflation targeting in practice lead to very similar patterns of central bank behavior. This raises the question why central banks insist on the strategies they use. In this paper, we develop an answer from political economy. After showing that closed-loop monetary strategies using similar information sets imply similar monetary policy performance, we argue that monetary strategies are helpful in solving internal and external coordination problems for the central bank. We illustrate the point by reviewing the Bundesbank's introduction of monetary targeting in the mid-1970s. Monetary targeting was important for the Bank as a signal that the previous monetary regime had been overcome, as a means to define the role of monetary policy vis-a-vis other players in the macro economic policy game, and to structure the internal monetary policy debate. The last section discusses the implications of this view for the new European Central Bank.Monetary growth targeting; Deutsche Bundesbank; European Central Bank; Closed-loop monetary strategies;

Managing Capital Flows: Experiences from Central and Eastern Europe. WP234. March 2008

The countries of Central and Eastern Europe went from being largely closed to being largely open to international capital flows. This paper discusses their experience with capital account liberalization and coping with large capital inflows. We start with a discussion of basic economic characteristics and the real convergence achieved so far, and then discuss the pace and sequencing of capital account liberalization and the degree of international financial integration over the past decade. We then analyze trends and patterns of capital inflows in these countries in recent years. These stylized facts are useful for understanding the macroeconomic implications and policy challenges of coping with large capital inflows, which we discuss next. Finally we conclude with policy implications for emerging Asian economies

Does Interbank Borrowing Reduce Bank Risk?

In this paper we investigate whether banks that borrow from other banks have lower risk levels. We concentrate on a large sample of Central and Eastern European banks which allows us to explore the impact of interbank lending when exposures are long-term and interbank borrowers are small banks. The results of the empirical analysis generally confirm the hypothesis that long-term interbank exposures result in lower risk of the borrowing banks

Fiscal and Monetary Policy Coordination in EMU

The purpose of this paper is to analyze and discuss the coordination of fiscal and monetary policies in EMU. In section 2, we develop a framework for studying monetary and fiscal policy in a monetary union to explore the implications of the common currency for policy coordination. We show that there is little need for coordinating monetary and fiscal policies in the long run. In section 3, we study the interaction of monetary and fiscal policies in the short run. A monetary policy firmly committed to price stability at the EMU level implies that the central bank controls aggregate output at the euro-area level, while national fiscal policies determine the distribution of aggregate demand across the participating countries. Thus, national governments are engaged in a purely distributional game with inefficient outcomes unless policies are coordinated. If monetary policy also pursues a goal of output stabilization, policy coordination should include the central bank together with the fiscal authorities. We also show that the proposal to restrict fiscal policies to the operation automatic stabilizers at the national level, which is now often made in EMU, does not solve the issue of policy coordination. Instead, it worsens the situation of the central bank unless automatic stabilizers are identical in all member economies. In section 4, we review the existing mechanisms for policy coordination and show that they are deficient, since they focus on the long run rather than the short run and largely ignore the interdependence of national economic policies and the ECB’s monetary policy. Section 5 concludes.

Interstate risk sharing in Germany: 1970-2006

We study the channels of interstate risk sharing in Germany for the time period 1970 to 2006 following the methodology of Asdrubali et al. (1996). Their framework allows us to estimate the degree of smoothing of a shock to a state's gross domestic product by factor markets, the government sector, and credit markets, respectively. For the time period from 1970 to 1994 pre-unification Germany we find that about 19 percent of shocks to a state's gross domestic product (GDP) are smoothed by private factor markets, 50 percent are smoothed by the German government sector, and a further 17 percent are smoothed through credit markets. For the post-reunification period, 1995 to 2006, the relative importance of the smoothing channels changes. In the complete sample, factor markets contribute around 50.5 percent to consumption smoothing, and credit markets contribute another 17.5 percent. The government sector's role is diminished: it smoothes around 10 percent of a shock. For this period, we also split our sample between West and East German states. In West Germany, 63 percent of idiosyncratic income shocks are smoothed out by factor markets; and another 15 percent by the government sector. In East Germany, factor markets smooth about 34.5 percent of the volatility in state GDP, the government sector about 19 percent, and another 18 percent are smoothed by credit markets. --Regional Risk-sharing,Factor Markets,Consumption Smoothing,Fiscal Federalism

Monetary policy in unknown territory: The European Central Bank in the early years

--