The recent literature has emphasized the importance of budgeting institutions, i.e., the rules
and norms under which governments plan their budgets, pass them through the legislature and
implement them, for achieving fiscal discipline. Empirical research in this area, documented
and summarized in Hallerberg et al. (2007), supports the view that good budgeting institutions
are a precondition for achieving the fiscal discipline desired for EMU. It is, therefore,
interesting to see whether budgeting institutions which are strongly conducive to fiscal
discipline prevent governments from using fiscal policy effectively for macro economic
stabilization. Hallerberg and von Hagen (1999) find that governments following the
“delegation approach” to budgeting institutions conduct more effective stabilization policies
than others.11 In this view the Stability and Growth Pact can operate as a substitute for week
budgetary institutions.
In order to test whether different qualities of institutions have indeed affected the budget
outcomes, we use four indicators developed by Hallerberg et al. (2007):
- Good budgeting institutions under either approach make fiscal policy more countercyclical;
- Good budgeting institutions under the contracts approach make fiscal policy more
countercyclical;
- Good budgeting institutions under the delegation approach make fiscal policy more
countercyclical;
- Stringent fiscal rules make fiscal policy more countercyclical.
We successively augment the panel regression shown in Table 1 with each of four dummy
variables coded 1 for the country and period when the corresponding property is found to
apply, and 0 otherwise.
The resulting regressions, not shown, fail to detect any significant effect. This may due to the
small size of the sample - data availability limits the sample to only nine euro area member
countries. Alternatively, it may be that these institutional differences have not affected the
governments’ ability to conduct countercyclical policies. This would indicate that there is,
from an institutional design perspective, no trade-off between fiscal discipline and effective
macro economic stabilization.
4. Mutual Insurance via Transfers
4.1. Principles of Fiscal Insurance
All existing federations provide mechanisms to redistribute income among their constituent
regions in response to economic developments that affect the latter in different ways
((Ingram, 1959). These mechanisms can be explicit, as in the case of Germany’s
“Finanzausgleich,” or the Canadian and Australian systems of fiscal equalization, or implicit,
as in the case of the US, where redistribution works through the federal government budget.
They can be organized horizontally, as in Germany and Canada, where state governments pay
and receive transfers to and from other state governments, or vertically, as in Australia, where
the federal government pays transfers to the individual territories in accordance with their
fiscal needs. They can be transfers between governments or the result of transfers to and from
private households through a nation-wide social insurance system such as unemployment
insurance. Such mechanisms are generally based on equity considerations: The aim of
protecting the individual against economic hardship is part of the solidarity defining a society.
As Delors (1989, p. 89) put it in his plea for a risk-sharing mechanism among the members of
the European Monetary Union (EMU), “... in all federations the different combinations of
federal budgetary mechanisms have powerful “shock-absorber” effects dampening the
11 Under the delegation approach, budgeting institutions lend significant agenda setting powers to the
finance minister. In contrast, the “contracts approach” builds on binding numerical targets negotiated
among all actors in the budget process at the beginning of the process. See Hallerberg et al (2007).