EUROPEAN FISCAL DISCIPLINE BEFORE AND AFTER EMU: CRASH DIET OR PERMANENT WEIGHT LOSS?

Abstract

This paper studies the evolution of European fiscal policies in three periods: the pre-Maastricht phase (to 1991); the runup to monetary union (1992–1997), and the stability pact phase (1998 onward). Using three separate indicators, we search for structural breaks that could signify a change in the average level of discipline in these periods. We find increased fiscal discipline only up to 1997. We conclude the new fiscal discipline was a temporary phenomenon, a product of the sanction of being denied entry to the Euro. After EMU, fiscal policy gradually loosened. A single structural break test will miss these dynamic effects, and could easily generate the false conclusion that fiscal discipline had tightened since the start of phase two of EMU.