variables that are 1 in the run-up to the single currency (from1992 to 1998) and after the coming into force
of the Stability and Growth Pact (in 1999), respectively, and 0 otherwise (third column of Table 4). We find
a significant Maastricht effect, but no significant SGP effect, suggesting that the former has provided a
binding constraint whereas the latter has not. This is consistent with earlier findings that the Stability and
Growth Pact failed to provide a binding fiscal constraint, as reported in Buti and van den Noord (2004) and
Koen and van den Noord (2005). The Maastricht dummy clearly takes away explanatory power from the
debt variable, suggesting that it essentially captures the same phenomenon, namely that high debt will
eventually weigh on primary expenditure. We have not retained the EMU-related dummies in subsequent
regressions.
37. The fourth column in Table 4 reports the regression result including the impact of the structural
stance indicator. The sign is as expected (positive, i.e. a tighter stance leads to higher primary expenditure).
The long-run impact is not negligible: a structural reform equivalent to a cut in the stance indicator by
2 standard deviations (roughly corresponding to the difference between e.g. France and New Zealand,
(Figure 5) reduces the primary expenditure ratio by around 1½ percentage points. Obviously structural
reform is not primarily aimed at reducing public expenditure, but this result does provide some evidence
that it might work out that way to a significant extent. One health warning is in place though, namely that a
country with a good regulatory environment for goods and labour markets may typically also have a good
fiscal framework in place, in which case we may be over-estimating the pure impact of structural policy
stances on public expenditure. However, either way, the basic message would still be that good policies are
associated with less rather than more public expenditure.
38. Finally, in order to capture possible upfront budgetary costs of structural reform, the regression
was re-run with the change in the stance indicator included as an explanatory variable. The sign is indeed
negative, as expected, but statistically significant only at the 10% level. This suggests that upfront cost may
occur but are small and not very stable over time or across countries, at least on the expenditure side of the
government account. Obviously, upfront cost may also take the form of tax cuts, which are not considered
here, but we doubt these are more significant.
Linking structural reform and fiscal performance: what can a macro-model tell?
39. Even if reforms have measurable direct beneficial effects on primary spending, their overall
budgetary impact also depends on economic feedback mechanisms that may be underestimated in a
reduced-form approach as the one above. Moreover, the link between a more favourable supply side and a
better macroeconomic and thus budgetary performance will vary across countries and the different
mechanisms that pull up demand. Budgetary outcomes also relate to the effect of different types of reforms
on endogenous variables that affect the public accounts, such as the monetary policy response - which is
particularly relevant in the euro area where individual countries have given up monetary policy autonomy.
Also the initial budgetary cost of reforms needs to be taken into account, associated with, for example, tax
cuts or compensation of losers from reforms. To clarify the various mechanisms that link structural reforms
and budgetary outcomes, several simulations were run with the OECD’s Interlink model. They help to
illustrate the effect of different types of reforms, including their macroeconomic effect as well as the
difference between concerted reform efforts versus reforms in a single country.
Effects of coordinated reform in monetary union
40. Co-ordination of structural reform in the euro area between the countries and monetary authority
could pay benefits, as will be illustrated below. To set a benchmark, we first construct scenarios in which
such co-ordination with monetary policy is absent. Three scenarios are run: first, total factor productivity is
raised; second, labour force participation increases; and third, structural unemployment is reduced. These
changes affect the large euro area countries and thus the overall performance of the euro area, for which the
level of potential output increases by 1¼ per cent over eight years. The reforms all imply lower inflation
and are accompanied by lower interest rates in a way that keeps real interest rates unchanged. Exchange
rates are assumed fixed, except in one simulation. Finally, tax rates are kept constant and also government
consumption and investment are held fixed in real terms. The results are represented with respect to a
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