Rules vs. Flexibility- Is there a Trade-off between Budgetary Sustainability and Budgetary Stabilisation?

This paper argues that uncertainty as to the sustainability of a country?s budgetary position will frustrate budgetary stabilisers to operate as a stabilisation device. Therefore, rather than irrelevant or harmful, the disciplinary incentive offered by the Stability Pact is even beneficial from a stabilisation point of view. This implies that the common trade-off between rules (of the Stability Pact to prevent the externalities from unsustainable budget balances) and flexibility (required to stabilise output) does not hold in this case. The empirical results presented in the paper indicate that a substantial, statistically significant and robust partial relation exists between government debt on the one hand and the degree of actual stabilisation on the other hand. In passing, this paper provides evidence that the degree of intertemporal budgetary stabilisation in EU countries is at least as large as the degree of interregional stabilisation built-in in the US federal budget.