Fiscal discipline in EMU? Testing the effectiveness of the Excessive Deficit Procedure

The Excessive Deficit Procedure (EDP), central to the Stability and Growth Pact, is criticized for both its procyclical effects and “ in contrast “ a perceived lack of enforcement. To test its actual effects, we construct a real-time database of EDP recommendations and estimate augmented real-time and ex-post fiscal reaction functions for a panel of EMU member states. We find that a 1% of GDP larger EDP recommendation leads to close to 1% of GDP of additional fiscal consolidation plans, and around 0.8% of actual consolidation. For countries in financial support programs we find that, while they did implement substantial consolidation measures, required and delivered consolidation efforts are less connected. Overall, our results suggest that EDP recommendations have substantially shaped euro area fiscal policy, especially in the years 2010-2014, when EDP recommendations were both largest and most frequent.
   
Keywords: EMU, Stability and Growth Pact, fiscal policy, real-time data.
JEL classifications: E02, E62, F45, H30, H68.

Working paper no. 607