Structural deficit limits as the rule-based framework for the coordination of NFP

The topic of public deficits and debts is one of the most discussed issues across the Euro-Atlantic area. Countries try to solve this problem by establishing fiscal rules, mostly in the form of budget and debt limits designed for elimination of the risks associated with excessive expansive fiscal policy and thus reducing the budget deficit the public debt. In response to this, on January 1, 2013, the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (the Fiscal compact) came into force. The limit is a rule-based framework for the coordination of national fiscal policies (NFP) in the European Union. EU member states, except the Czech Republic and Great Britain, will have to include the requirement for budgetary discipline and the automatic correction mechanism into their national legal systems. The new treaty requires the national budgets of participating member states to be balanced or in surplus. Their annual structural government deficit must not exceed 0.5 % of nominal GDP. The requirement for compliance with structural deficit limit was the reason why the Czech Republic and the Great Britain refused to sign the treatment.

There are different approaches to structural deficit estimation that also achieve different results. The calculation of the structural deficit is performed using different econometric methods. For example for the EU two methods are commonly used in the literature.  The first one, used by the European Commission, is based on estimation of potential output using Cobb-Douglas production function. The second one, applied by the European Central Bank, estimates structural deficit directly from the cyclical development of the individual components of GDP and from the budget´s elasticity on the cycle.

However, insufficient space is devoted in the literature to the discussion of different approaches for structural deficit´s calculation and to possible solutions to this problem for the implementation to fiscal rules.

The paper deals with the structural deficit limits defined in the Stability and Growth Pact. In this paper we compare the disaggregated approach (known as the OECD methodology), aggregated approach and selected business cycle filtering techniques. Finally, we discuss the adequacy of these limits signed by 25 EU Member States in the Stability and Growth Pact.

Keywords: fiscal rules, fiscal policy, cyclical adjustment, structural fiscal balance, business cycle fluctuations