Proceedings from the ECFIN Workshop "The budgetary implications of structural reforms" - Brussels, 2 December 2005

A further argument in the literature (Annett et al. 2004, European Commission, 2005, dating back
to Eichengreen and Wyplosz, 1998) refers to a possibly limited political capital which prevents
governments following different politically sensitive projects at the same time. Translated in our
stylized setting this is no particularly compelling argument to expect increasing deficits in a
reform period but it simply suggests that periods of structural reforms are unlikely to be periods of
budgetary consolidation either. The validity of this particular argument, of course, depends on the
answer to this paper’s overall question whether there is a short-run conflict between consolidation
and reform at all.

Period SA:

Finally, the fiscal situation in the immediate aftermath of reforms is characterized by the
continuous transcendence from the immediate reform period towards the long-run (positive)
outcomes. The question how quick the long-run is reached is important for the acceptance of
reforms from the start.46 There are different reasons why the future is heavily discounted in
political processes. A classical political argument refers to election cycles and the short-
sightedness of political actors maximizing re-election chances. A behavioural economics
argument hints to short-term impatience characterizing human behaviour. Standard assumptions
that people maximize the sum of exponentially discounted expected utilities are not supported by
experimental research. Instead, a preference bias towards the presence exists in the sense that the
discount rate between today and tomorrow is significantly larger than between two periods
somewhere in the future (Frederick et al., 2002).

Period S

In the stylized setting, the periods BR, R, and SA are framed by periods of stable institutional
setting, S. In S, existing structures correspond to something like a stable equilibrium and
transitory effects from former reforms have tapered off.47

⁴⁶ In this sense, any attempt to study the economic consequences of observable reform events necessarily suffers from a selection bias. Reforms
associated with pronounced J-curve effects are less likely to occur compared to the ones resulting in a quick transcendence to the beneficial
“long-run”.

⁴⁷ In reality, things are more complicated as one reform step may breed the next one if, for example, the effects hoped for do not materialize fully,
see the model in section 4.

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