Political Biases in Fiscal Policy: Reconsidering the Case for the Maastricht Fiscal Criteria

Abstract

This paper reconsiders the arguments for binding fiscal and budget rules such as those implied by the Maastricht Treaty fiscal criteria for a monetary union in Europe. Given the concern in Europe about “excessive” budget deficits caused by political biases in fiscal policy, we consider in a theoretical framework the trade-off between rules and discretion in fiscal policy in the presence of politically motivated fiscal deficits. We discuss the role of a political bias when deficits are motivated by economic shocks such as recessions and in economies which are open to international trade in assets and goods. We find that endowing politically biased governments with the ability to respond to economic shocks with deficit finance will not exacerbate the existing political biases. In an open economy, the ability to borrow abroad will significantly increase the deficit. However, restrictions to public foreign borrowing will not reduce the political bias as long as the private sector has access to international capital markets at the same terms as the government. The analysis suggests that a certain degree of fiscal discretion might be beneficial and that Maastricht type of rules might impose excessive constraints on the behavior of fiscal authorities.