Do fiscal councils reduce fiscal policy procyclicality?

ABSTRACT

Using a panel of 35 advanced economies over the period 1990–2020, we investigate the effect of fiscal councils and their individual characteristics on fiscal policy. We find that the response of fiscal policy was procyclical; however, fiscal councils with enhanced remit, strong independence and accountability, and sufficient resources can mitigate procyclicality. A series of robustness checks revealed that the ability of fiscal councils to mitigate fiscal policy procyclicality is particularly relevant in the EU and euro area countries, in countries with weak governance and in particular in the period after the Global Financial Crisis. The results are robust when accounting for the likely endogeneity between fiscal councils and fiscal procyclicality.

JEL CLASSIFICATION:

• Fiscal councils
• fiscal policy
• procyclicality
• business cycle

JEL:

• C23
• E32
• E62
• H30

Acknowledgments

We would like to thank the editor Mark Taylor and four anonymous referees for their very helpful comments. We also thank Panagiotis Konstantinou and Nikolaos Giannakopoulos.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Supplementary material

Supplemental data for this article can be accessed online at https://doi.org/10.1080/13504851.2022.2130142.

Notes

¹ We considered countries that have established a fiscal council based on the information in Davoodi et al. (2022). See Supplementary Material – Appendix H.

² See supplementary material – Appendix, A for analytical information about the construction of these dummy variables.

³ All the alternative estimators, even the stricter one step system GMM, are for the most part similar to the OLS fixed effects reported in Table 1; the results are qualitatively similar when we use the unemployment rate instead of the output gap (see Supplementary Material – Appendix B). The ability of IFCs to mitigate fiscal policy procyclicality is particularly relevant in EU and euro area countries, in countries with weak governance and in particular in the period after the Global Financial Crisis (see Supplementary Material, Appendices C-D-E).