In the fiscal policy domain, the elements of a good rule are: It is clear and easy to understand; it is binding, i.e. has a basis in law – ideally at the constitutional level; and it is equipped with a specific sanctioning mechanism. Finally, it must make provision for exceptions, and these should be clearly defined. In the monetary policy domain, too, there are certain requirements regarding what makes a good rule. First, it must set out how the central bank should use its policy tools to achieve the goal of price stability. It defines criteria according to which monetary policy measures are taken. For many central banks, inflation forecasts play an important role. On the one hand, they serve as the main indicator for the interest rate decision. On the other, they are an important communication tool. A good rule creates a certain degree of transparency vis-à-vis the public, and makes monetary policy more predictable. It provides an anchor for inflation expectations and helps to improve the credibility of monetary policy. Second, we need a culture of stability which is well anchored in the minds of both politicians and the general public – part of the national mentality (cf. chart 6). Economic literature has repeatedly demonstrated that certain political structures and a culture of stability are mutually reinforcing. 7 For fiscal policy, these structures can be, for example, fiscal federalism (tax competition), the subsidiarity principle, direct democracy structures and political continuity (e.g. the concordance principle).
6 To achieve a balanced budget, it is necessary to limit the room for manoeuvre in the political domain. To this end, politicians use fiscal rules as a form of self-imposed restraint (cf. chart 5). As a result, automatic stabilisers now play an increasingly important role compared to discretionary measures. The automatic stabilisers are designed to fulfil the three T-criteria. Unemployment insurance is an important automatic stabiliser. It triggers automatic government expenditure or receipts, depending on the economic situation, and thus has an immediate, or timely effect. Second, it provides targeted support to those affected by the economic downswing. Third, it is temporary. But rules alone are no guarantee of stability, for there is often considerable room for interpretation when implementing them. There is always a way to circumvent them. Fiscal rules existed in a number of countries even before the onset of the sovereign debt crisis. A good example is the Maastricht criteria in the EU, which various countries repeatedly failed to meet, without effective sanctions being brought to bear. The history of monetary policy is also rich with examples, from all over the world, which show how a departure from the objective of price stability can have drastic consequences for the economy. If the central bank is unable to ensure price stability, it calls its credibility into question, and thereby runs the risk of reducing the effectiveness of future measures. What factors help to ensure that rules are complied with? First, we need good rules.