Asymmetric Fiscal Dynamics and the Significance of Fiscal Rules for EMU Public Finances

Since the onset of the international financial and economic downturn, the issue of the sustainability of public finances has strongly repositioned itself at the center of economic policy debates, as a number of chronic fiscal ailments for many EMU countries still need to be effectively addressed for they pose new challenges for future economic policy. In this work we take stock of the fiscal situation in the EMU and attempt to dissect some of the most salient aspects of fiscal performance for a number of member states during the last decade, by concentrating on the evolution of key fiscal variables in a unified framework of analysis. We focus on the asymmetric evolution of public finances, in order to assess whether this has been the outcome of discretionary measures (including the massive stimulus packages as a response to the crisis) and the effects of automatic stabilizers or also due to poor fiscal management and lack of fiscal discipline within the existing institutional framework. The analysis is then taken a step further by estimating the requirements for long-term sustainability of public finances in the EMU member states in our sample. Within this context, the issue of the effectiveness of existing rules and institutions is addressed, as institutional arrangements are crucially related to fiscal performance. We conclude by highlighting the importance of adopting a cohesive and enabling framework for public finance stabilization and adjustment purposes. Our view is that since the root causes of fiscal problems in the Eurozone are diverse, responding to the diversity of fiscal challenges in a symmetric way i.e. applying a 'one-size fits all' EMU strategy, may prove sub-optimal for individual country fiscal sustainability objectives. In fact, fiscal policy responses will inevitably be asymmetric. This asymmetric evolution of public finances puts into question the sustainability objective and thus convergence of the EMU as a whole.