Does it cost to be virtuous? The macroeconomic effects of fiscal constraints

Canova, Fabio; Pappa, Evi

Does it cost to be virtuous? The macroeconomic effects of fiscal constraints

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NBER International Macro Annual 2005

Abstract

We study whether and how fiscal restrictions alter the business cycle features of macrovariables for a sample of 48 US states. We also examine the typical transmission properties of fiscal disturbances and the implied fiscal rules of states with different fiscal restrictions. Fiscal constraints are characterized with a number of indicators. There are similarities in second moments of macrovariables and in the transmission properties of fiscal shocks across states with different fiscal constraints. The cyclical response of expenditure differs in size and sometimes in sign, but heterogeneity within groups makes point estimates statistically insignificant. Creative budget accounting is responsible for the pattern. Implications for the design of fiscal rules and the reform of the Stability and Growth Pact are discussed.