The Stability and Growth Pact: A European Answer to the Political Budget Cycle?

Abstract: The existing literature on political budget cycles (PBCs) looks at the temptation for incumbent governments to run a greater deficit before an election by considering the characteristics of the incumbent. We propose here to look at the signals the incumbent receives from the voters. For this purpose, we consider the votes from the previous national elections and see whether they may influence the incumbent government to run a sound fiscal policy or an expansionary fiscal policy. Since Europe has been equipped with two fiscal rules under the Stability and Growth Pact: a deficit and debt ceiling, the possibility of PBCs is particularly relevant. Can we find evidence of a 'political budget cycle' before 1993, and did the fiscal rules prevent the existence of a 'political budget cycle' afterwards? To address these questions, we use a cross-sectional time-series analysis of European countries from 1979 to 2005.