A key question in the decades-old debate on the institutional framework of the EMU is how to ensure fiscal discipline in the member countries.
Two mechanisms are typically discussed, namely (i) numerical fiscal rules with a corresponding surveillance framework and (ii) the disciplining forces of the financial markets. While there are many contributions on the pros and cons of rules and markets as disciplining mechanisms for fiscal policy, little attention has been paid to their interaction. This paper seeks to uncover whether fiscal rules and market discipline act as complements or substitutes. We show that, depending on their design and implementation, the two mechanisms can indeed strengthen each other. However, they can just as well undermine each other’s effectiveness. As a case study, the paper looks at fiscal policies in Italy in 2018 and 2019. More specifically, it analyses the interplay of the Italian government, the European Commission and Italy’s sovereign spreads with the aim of developing an understanding of how rules and markets operate together in EMU’s fiscal governance framework.
Maximilian Freier is Senior Economist in the European Central Bank’s Fiscal Policies Division. His research focusses on Europe’s Economic and Monetary Union. He is an alumnus of LSE’s European Institute.
Paul De Grauwe is John Paulson Chair in European Political Economy at the European Institute, LSE.