Working Paper: CEPR ID: DP4759
Authors: Jürgen von Hagen; Guntram Wolff
Abstract: Fiscal rules, such as the excessive deficit procedure and the stability and growth pact (SGP), aim at constraining government behaviour. Milesi-Ferretti (2003) develops a model in which governments circumvent such rules by reverting to creative accounting. The amount of this creative accounting depends on the reputation cost for the government and the economic cost of sticking to the rule. In this Paper, we provide empirical evidence of creative accounting in the European Union. We find that the SGP rules have induced governments to use stock-flow adjustments, a form of creative accounting, to hide deficits. This tendency to substitute stock-flow adjustments for budget deficits is especially strong for the cyclical component of the deficit, as in times of recession the cost of reducing the deficit is particularly large.
Keywords: debt-deficit adjustments; ESA 95; excessive deficit procedures; fiscal rules; stability and growth pact; stock-flow adjustments
JEL Codes: E62; H61; H62; H63; H70
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| SGP (F53) | increase in stock-flow adjustments (F32) |
| EDP (O00) | increase in stock-flow adjustments (F32) |
| stock-flow adjustments (F32) | lower recorded deficits (H68) |
| stock-flow adjustments (F32) | manage reported deficits (H62) |
| economic downturns (F44) | increase in stock-flow adjustments (F32) |
| SGP (F53) | creative accounting (M41) |
| stock-flow adjustments (F32) | cyclical component of deficits (H62) |