Fiscal governance in the European Union

Fiscal discipline is a key challenge for all economies. Policymakers must address the common pool problem where beneficiaries of public spending fail to fully realize the costs to taxpayers. Democratically elected governments tend to have a deficit bias and therefore, they are averse to increasing taxes and cutting spending to achieve sustainable public finances. To resolve this issue, economists have advised governments to set fiscal rules. A fiscal rule represents legislated and long-term numerical limits on budgetary aggregates pertaining to debts, deficits, expenditures and revenues. Fiscal rules can only work if appropriate institutions for monitoring and enforcement mechanisms are in place and if they are supported by strong political commitment. Due the increases in public debt during the 1970s and 1980s over 80 countries have adopted national or supranational fiscal rules. The European Union is not a fiscal union but, it relies on fiscal coordination among member states to prevent excessive levels of deficit and debt to ensure the stability of its single currency. European policymakers have developed a very sophisticated framework of fiscal rules which includes the 1999 Stability and Growth Pact, the 2005 reforms, the 2011 Six Pack, the 2012 Fiscal Compact, and the 2013 Two Pack. The European Union has strengthened its fiscal frameworks, in particular its fiscal rules as a key response to the fiscal legacy of the crisis. The purpose of this paper is to analyze the effectiveness of the overall European fiscal framework and to present options to improve it.

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