Institutions and constraints in fiscal policy: three empirical essays

This thesis investigates how institutional arrangements and budgetary constraints shape the conduct and effectiveness of fiscal policy, with particular emphasis on European economies. Across three empirical essays, it examines two central dimensions of fiscal governance: the role of fiscal rules in determining the cyclical stance of discretionary fiscal policy and the influence of expenditure rigidity on the effectiveness of fiscal consolidation. The first chapter analyses the relationship between the European fiscal framework and fiscal cyclicality, placing particular emphasis on the distinction between real-time and ex-post information. Using time-varying estimates of fiscal cyclicality, it shows that revisions to potential output and, in particular, to the Non-Accelerating Wage Rate of Unemployment can substantially affect the measured response of fiscal policy to the business cycle. The results indicate that, when fiscal behaviour is evaluated using the information actually available to policymakers, fiscal rules appear less supportive of counter-cyclical policy, especially in the countries most exposed to the global financial and sovereign debt crises. The second chapter develops this analysis by investigating whether the effect of fiscal rules depends on the level of public debt. Combining time-varying estimates of fiscal cyclicality with a panel threshold framework, the analysis identifies a robust debt threshold of approximately 90 percent of GDP. Above this level, stronger fiscal rules are associated with a more pro-cyclical fiscal stance. The chapter further addresses potential endogeneity in the estimation of fiscal cyclicality by employing a time-varying instrumental-variable approach. The third chapter shifts the focus from institutional rules to the composition of public expenditure and examines how budget rigidity affects the success and macroeconomic consequences of fiscal consolidations. Budget rigidity, defined by a high share of pensions and compensation of employees in primary expenditure, reduces governments’ ability to adjust spending composition. In high-rigidity environments, consolidation therefore relies more heavily on cuts to flexible expenditure, particularly public investment, generating larger output losses, slower recoveries, and less effective reductions in the debt-to-GDP ratio. Taken together, the three essays show that fiscal constraints cannot be evaluated independently of the macroeconomic and budgetary conditions under which they operate. The effectiveness of fiscal policy depends not only on the existence and strength of institutional rules, but also on the information available to policymakers, the level of public debt, and the degree of flexibility in the composition of government expenditure.