The Network on SSRN: R. Daniel Kelemen and Terence Teo, "Law, Focal Points and Fiscal Discipline in the United States and the European Union"

We wanted to alert readers to this piece by network member R. Daniel Kelemen and Terence Teo (both Rutgers University) on "Law, Focal Points and Fiscal Discipline in the United States and the European Union," forthcoming in the American Political Science Review. An abstract is reproduced below and the full article can be downloaded from SSRN here.

***

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 US 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.