Law, Focal Points, and Fiscal Discipline in the United States and the European Union

• Published in: The American political science review Vol. 108; no. 2; pp. 355 - 370
• Main Authors: KELEMEN, R. DANIEL, TEO, TERENCE K.
• Format: Journal Article
• Language: English
• Published: New York, USA Cambridge University Press 01.05.2014
• Subjects: Academic Language; Balanced budgets; Bond markets; Bonds; Borrowing; Cost; Courts; Credit ratings; Debt; Debt (Financial); Decision-making; Deterrence; Effectiveness; Enforcement; Euro Zone; Eurocurrency market; Europe; European Union; Eurozone; Federal budget deficit; Financial Policy; Fiscal policy; Focal points; Judicial process; Law; Law enforcement; Logical Thinking; Markets; Political science; Public officials; Punishment; Regulation; Rule of law; Sovereign debt; Sovereignty; State budgets; State Government; Threats; Treaties; U.S.A; United States; United States > US
• ISSN: 0003-0554; 1537-5943
• DOI: 10.1017/S0003055414000100

Many studies suggest that strict balanced budget rules can restrain sovereign debt and lower sovereign borrowing costs, even if those rules are never enforced in court. Why might public officials adhere to a rule that is practically never enforced in court? Existing literature points to a legal deterrence logic in which the threat of judicial enforcement deters sovereigns from violating the rules in the first place. By contrast, we argue that balanced budget rules work by coordinating decentralized punishment of sovereigns by bond markets, rather than by posing a credible threat of judicial enforcement. Therefore, the clarity of the focal point provided by the rule, rather than the strength of its judicial enforcement mechanisms, determines its effectiveness. We develop a formal model that captures the logic of our argument, and we assess this model using data on U.S. states. We then consider implications of our argument for the impact of the balanced budget rules recently imposed on eurozone states in the Fiscal Compact Treaty.