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Persistent and widespread evidence of fiscal indiscipline raises questions about the likely distortions causing such behaviour. To improve policymakers’ incentives,
institutional arrangements ranging from legally binding fiscal rules to public commitments supported by strong accountability mechanisms and procedural arrangements have received considerable attention. The underlying idea is that welldesigned institutions can effectively discourage deviations from desirable policies because they somehow “tie the hands” of elected policymakers. Yet the significance of the role of institutions in improving policy outcomes has been the subject of debate. The issue revolves around the extent to which institutions themselves can truly alter the motivations of policymakers.
In the first part of the paper, an illustrative model of fiscal policy discusses the theoretical underpinnings of fiscal institutions. The deficit bias comes from electoral
uncertainty because it reduces the time horizon of partisan policymakers. In principle, institutions—such as a constitutional amendment banning excessive deficits—can
alleviate such bias. In practice, however, the credibility of such institutions remains an open question. I therefore analyse the credibility of fiscal rules and show that
democratic accountability is one natural mechanism through which deviations from the rule can be made costly enough to deter cheating. However, the power of voters is
limited by the lack of budgetary transparency and by the possibility that the deficit bias be rooted elsewhere than in myopic partisanship.
The second part of the paper explores some of the empirical implications of the theory, looking specifically at fiscal behaviour in a panel of 14 EU countries. I first
confirm that government instability (which entails greater uncertainty for incumbents)is a statistically significant and quantitatively meaningful source of deficit bias. I then quantify econometrically the relationship between institutions and fiscal outcomes,and investigate whether the relationship between institutions and outcomes is causal.(This is an important question because intrinsically well-behaved governments may
adopt strict rules and institutions merely to signal a strong commitment to discipline).
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