Current Issue

Seoul Journal of Economics - Vol. 33 , No. 4

[ Article ]
Seoul Journal of Economics - Vol. 33, No. 3, pp.307-331
Abbreviation: SJE
ISSN: 1225-0279 (Print)
Print publication date 31 Aug 2020
Received 13 May 2020 Accepted 25 May 2020
DOI: https://doi.org/10.22904/sje.2020.33.3.003

The Global Pandemic, Policy Space and Fiscal Rules to Achieve Stronger Stabilization Policies
Michael M. Hutchison
Michael M. Hutchison, Distinguished Professor of Economics, Department of Economics, E2, University of California, Santa Cruz, Santa Cruz, CA 95064, Tel: +01 831-459-2600 (hutch@ucsc.edu)

JEL Classification: E32, E62, H5


Abstract

The world economy was slowing prior to the onset of the Covid-19 pandemic. The slowdown began after a record-long period of expansion marked with record lows in unemployment and strong economic indicators along most dimensions. Even at a high point of the business cycle, however, “depression style” economic policies of very low or zero policy interest rates and large budget deficits were being followed in many countries—partly due to the lingering effects of the Great Recession and partly due the long-standing problem of “deficit bias” in fiscal policy. Fiscal responses to the Covid-19 shock in the form of wage support, business loans and other programs in 2020 were substantial and necessary but, following already large fiscal deficits and growing government debt, have aggravated the problem of long-term fiscal solvency. In some cases, concerns over record peacetime budget deficits constrained government’s willingness to pursue further rounds of fiscal stimulus as the Covid-19 crisis deepened. This article argues that deficit bias constrained discretionary fiscal policy actions arises from political economy factors and demonstrates that fiscal rules are an important instrument to mitigate deficit bias and restore countries to longer-term solvency. Countries with strong fiscal rules had much better fiscal and debt positions prior to the Great Financial Crisis, allowing them in turn to pursue much more stimulative fiscal policies in response to the crisis. The same situation faced policy makers at the onset of the pandemic economic crisis-- those with strong fiscal rules were in a much better position to provide large fiscal responses to support the economy without endangering national debt solvency. Facilitating long-term fiscal solvency and allowing for larger discretionary fiscal actions in crisis situations provides a strong argument for the strengthening and enforcement of fiscal rules around the world.


Keywords: Pandemic, Fiscal rules, Stabilization Policy

Acknowledgments

The author thanks an anonymous referee for helpful comments.


References
1. Afonso, António, and Ana Sofia Guimarães. “The Relevance of Fiscal Rules for Fiscal and Yield Developments.” Working Papers 05/2014. Lisboa School of Economics & Management (2014).
2. Afonso, António, and Sebastian Hauptmeier. “Fiscal Behaviour in the European Union: Rules, Fiscal Decentralization and Government Indebtedness.” Working Paper Series 1054. European Central Bank (2009).
3. Alesina, Alberto, and Guido Tabellini. “A Positive Theory of Fiscal Deficits and Government Debt.” The Review of Economic Studies 57 (1990): 403-414.
4. Beetsma, R. and Xavier Debrun. “Reconciling Stability and Growth: Smart Pacts and Structural Reforms.” IMF Staff Papers 51 (2004): 431-456.
5. Beetsma, Roel, and Harald Uhlig. “An Analysis of the Stability and Growth Pact.” The Economic Journal 109 (1999): 546-571.
6. Bergman, M. and M. Hutchison. “Economic Stabilization in the Post-Crisis World: Are Fiscal Rules the Answer?” Journal of International Money and Finance 52 (2015): 82-101.
7. Bergman, M. and M. Hutchison. “Fiscal Procyclicality in Emerging Markets: The Role of Institutions and Economic Conditions,” forthcoming International Finance 20 (No. 2 2020).
8. Bergman, M., M. Hutchison and S. Jensen. “Do Sound Public Finances Require Fiscal Rules or is Market Pressure Enough?” European Commission Directorate-General for Economic and Financial Affairs, European Economy, Economic Papers 489 (April 2013).
9. Bergman, M., M. Hutchison and S. Jensen. “Shaping the Fiscal Policy Framework: Lessons from Fiscal Consolidations in Denmark and Sweden,” with U.M. Bergman and S. Jensen, Reform Capacity and Macroeconomic Performance in the Nordic Countries, Oxford University Press (2015).
10. Bergman, M., M. Hutchison and S. Jensen. “Measurement and Effectiveness of National Fiscal Rules and Governance in the European Union,” Chapter 8 in Makropolitik i kris (Macroeconomics in Crisis), published by Knut Wicksells Centrum för Finansvetenskap, Lunds Universitet (2016a).
11. Bergman, M., M. Hutchison and S. Jensen. “Promoting sustainable public finances in the European Union: The role of fiscal rules and government efficiency.” European Journal of Political Economy 44 (2016b): 1–19.
12. Bergman, M., M. Hutchison and S. Jensen. “European policy and markets: Did policy initiatives stem the sovereign debt crisis in the euro area?” European Journal of Political Economy 57 (2019): 3-19.
13. Corbacho, Ana, and Gerd Schwartz. “Fiscal Responsibility Laws,” in Kumar, M., Ter-Minassian, T., (Eds.), Promoting Fiscal Discipline. International Monetary Fund, Washington DC (2007).
14. Dahan, M., and M. Strawczynski. “Fiscal Rules and Composition Bias in OECD Countries.” CESifo Working Paper Series 3088. CESifo Group Munich (2010).
15. Debrun, Xavier, et al. “Tied to the Mast? National Fiscal Rules in the European Union.” Economic Policy 23 (2008): 297-362.
16. Foremny, D. “Sub-national Deficits in European Countries: The Impact of Fiscal Rules and Tax Autonomy.” Journal of European Political Economy 34 (2014): 86-110.
17. Frankel, J. “A Solution to Fiscal Procyclicality: the Structural Budget Institutions Pioneered by Chile.” Journal Economía Chilena (The Chilean Economy) 14 (No. 2 2011): 39-78. (Issued as NBER Working Paper No.16945 (April 2011))
18. Gopinath, Gita. “The Great Lockdown: Worst Economic Downturn Since the Great Depression.” International Monetary Fund Blog (April 14, 2020).
19. Hallerberg, Mark, and Jürgen Von Hagen. ”Electoral Institutions, Cabinet Negotiations, and Budget Deficits in the European Union,” in Poterba, J., von Hagen, J., (Eds.), Fiscal Institutions and Fiscal Performance. University of Chicago Press (1999).
20. Holm-Hadulla, Fédéric, Sebastian Hauptmeier, and Philipp Rother. “The Impact of Expenditure Rules on Budgetary Discipline over the Cycle.” Applied Economics 44 (2012): 3287-3296.
21. Iara, Anna, and Guntram B. Wolff. “Rules and Risk in the Euro Area.” European Journal of Political Economy 34 (2014): 222-236.
22. Krogstrup, Signe, and Charles Wyplosz. “A Common Pool Theory of Supranational Deficit Ceilings.” European Economic Review 54 (2010): 269-278.
23. International Monetary Fund. World Economic Outlook, October 2019 (2019).
24. International Monetary Fund. World Economic Outlook, April 2020 (2020).
25. International Monetary Fund. Fiscal Monitor, April 2020 (2020).
26. International Monetary Fund. IMF Blog. “Fiscal Policies to Contain the Damage from COVID-19.” (April 15 2020)
27. Nerlich, Carolin, and Wolf Heinrich Reuter. “The Design of National Fiscal Frameworks and their Budgetary Impact.” ECB Working Paper Series No. 1588 (2013).
28. Persson, Mats, Torsten Persson, and Lars EO Svensson. “Time Consistency of Fiscal and Monetary Policy.” Econometrica 55 (1987): 1419-1431.
29. Persson, Mats, Torsten Persson, and Lars EO Svensson. “Time Consistency of Fiscal and Monetary Policy: A Solution.” Econometrica 74 (2006): 193-212.
30. Persson, Torsten, and Lars EO Svensson. “Why a Stubborn Conservative would Run a Deficit: Policy with Time- Inconsistent Preferences.” The Quarterly Journal of Economics 104 (1989): 325-345.
31. Primo, D. “Stop Us Before We Spend Again: Institutional Constraints on Government Spending”. Economics & Politics 18 (2006): 269-312.
32. Sacchi, Agnese, and Simone Salotti. “The Impact of National Fiscal Rules on the Stabilisation Function of Fiscal Policy.” European Journal of Political Economy 37 (2015): 1-20.
33. Velasco, A. “Debts and Deficits with Fragmented Fiscal Policymaking.” Journal of Public Economics 76 (2000): 105-125.
34. Von Hagen, Jürgen, and Ian J. Harden. “Budget Processes and Commitment to Fiscal Discipline.” European Economic Review 39 (1995): 771-779.
35. Weingast, Barry R., Kenneth A. Shepsle, and Christopher Johnsen. “The Political Economy of Benefits and Costs: A Neoclassical Approach to Distributive Politics.” Journal of Political Economy 89 (1981): 642-664.
36. Wierts, P. “Fiscal rules and fiscal outcomes in EMU – Theory and evidence.” PhD thesis. University of Reading (2008).
37. Wyplosz, C. “Fiscal Policy: Institutions versus Rules.” National Institute Economic Review 191 (2005): 70-84.