Do fiscal rules matter for growth?

Abstract

We study the relevance of fiscal rules for growth in an European Union (EU) panel. Our results show that they foster growth, while stricter fiscal rules mitigate the adverse impact on growth from big governments. Moreover, more recent EU member states have gained from the implementation of fiscal rules.

Keywords:

• fiscal rules
• growth
• government size
• panel data

JEL Classification:

• C23
• E62
• H60

Notes

¹ For instance, Andersson and Minarik (2008) discuss design choices for fiscal rules.

UECE is supported by FCT (Fundação para a Ciência e a Tecnologia, Portugal).

² For a recent survey article on the relationship between government size and economic growth, the reader should refer to Bergh and Henrekson (2011).

³ These variables are in logs.

⁴ Wierts (2008) reports empirical evidence that expenditure rules can limit to some extent the expenditure bias, thus its negative impact on output.

⁵ The correlation coefficient of fiscal with exp and bb is 61% and 83%, respectively (statistically significant at the 1% level).

⁶ Our econometric specification can be derived algebraically from a (Cobb–Douglas) production function approach.

⁷ As far as information on the choice of lagged levels (differences) used as instruments in the differences (levels) equation as work by Browsher (2002) and, more recently, Roodman (2009) has indicated, when it comes to moment conditions (as thus to instruments) more is not always better. The GMM estimators are likely to suffer from ‘overfitting bias’ once the number of instruments approaches (or exceeds) the number of groups/countries (as a simple rule of thumb). In the present case, the choice of lags was directed by checking the validity of different sets of instruments.

⁸ In our system-GMM regressions the Hansen-J statistic is associated with p-values larger than 10%. This statistic tests the null hypothesis of correct model specification and valid overindentifying restrictions, that is, validity of instruments.

⁹ This nonparametric technique assumes the error structure to be heteroskedastic, autocorrelated up to some lag and possibly correlated between groups.

¹⁰ Driscoll–Kraay estimation results of Equation 1(1) instead (not shown) yield negative and statistically significant coefficients for Gwartney–Lawson's measure, total government expenditures and public debt. Moreover, bb, the debt rule index, is found to have positive effects on growth.

¹¹For instance, in Column 1 in Table 3, we have