Fiscal policy at a crossroads: The need for constrained discretion

by Antonio Fatás and Ilian Mihov

Vox
June 17, 2010

The inability of governments to maintain fiscal discipline is not new. But this essay argues that numerical budget rules are a far from optimal solution. They cannot be enforced and can produce highly procyclical policy during downturns. Instead, it proposes constraints on fiscal discretion imposed, monitored, and enforced by an independent fiscal policy council.

The Eurozone is at a difficult juncture when it comes to fiscal policy.

• Members’ debts are at levels not seen since World War II.
• Default risk is on the rise for some of the Eurozone governments.
• Financial markets have pressured governments to adopt concrete plans for reducing debts and deficits levels in the short and medium term.

But the need for massive fiscal adjustment comes at the wrong time. The economic recovery is weak and many voices call for additional fiscal stimulus. The difficult task facing Eurozone finance ministers is to “strike the right balance” between the short-term demands of stabilising aggregate demand and the long-term need for sustainability.

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