Credibility of Fiscal Policies and Independent Fiscal Bodies

In this paper we address the problem of credibility in fiscal policy. In many instances fiscal policy as conducted by governments is not perceived as credible. The targets set forward by government are often not met and usually the divergence is on the negative side. Taxes are overestimated and spending is underestimated, leading to a deficit bias and growing government debts. To enhance the credibility of fiscal policy several schemes are put forward. Most frequently used are fiscal rules that replace discretionary decision making. Fiscal rules however are difficult to sanction and although they can improve the quality of fiscal policy, they do not guarantee sound fiscal policy. Therefore it is sometimes suggested to install fiscal councils on top of the fiscal rules. Fiscal councils with tasks in forecasting and assessing fiscal policy have been and are being introduced in more and more countries. Some economists want to go further however and propose to establish fiscal councils with independent powers to conduct fiscal policy within the limits that parliament lays down. The central research themes of this paper are the questions whether and how fiscal rules and independent fiscal institutions can improve the credibility of fiscal policy. The first research question can be answered affirmatively given the experience in monetary and regulatory policy. Regarding the second research question the challenge is to disentangle the distributional from the stabilization elements in fiscal policy. If that can be done stabilization could be delegated to an independent fiscal body while distribution should remain a political prerogative.