## _wp0882

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---

### I. Introduction
- Principal contribution: first statistical examination of the determinants of budget reform using time-series measures of the quality of budget institutions for 23 European economies during 1991-
- Builds on literature showing strengthened institutional framework for the budget process can help improve fiscal discipline and performance (representative contributions cited).
- Revisited prior cross-sectional findings using within-country over-time variation and a wide variety of variables; authors report: "We continue to find that strong budget institutions are associated with greater fiscal discipline even when the politics is unfavorable to such discipline."

### II. Data, Index Construction, and Empirical Approach
- Index of budget institutions’ quality:
  - Constructed over the period 1994-2004 for 23 European countries.
  - Index ranges from zero to four.
  - Built across three stages of the budgetary process: preparation (weight: 0.33), authorization (weight: 0.33), implementation (weight: 0.33).
  - Sources: annual fiscal budget laws, IMF ROSC Fiscal Transparency Module, Hallerberg, Strauch, and von Hagen (2007), and direct consultation of country authorities where needed.
- Dependent variable and sample:
  - Dependent variable: change in budget institutions two years ahead (four categories: a large improvement, an improvement, no change, a setback).
  - Initial sample: 102 observations (78 with no change; 12 with strengthening up to 0.7 point designated “an improvement”; 6 with strengthening larger than 0.7 designated “a large improvement”; 6 with an institutional setback). After adjustments, about 100 observations used.
- Methodology:
  - Ordered logit regressions with robust standard errors.
  - Inclusion of an “institutional gap” variable equal to (4 − country index).
  - Year and country fixed effects included throughout.
- Index coding examples (decimal precision preserved):
  - Preparation — General constraint coding: 4.00; 3.00; 2.00; 1.00; 0.00.
  - Implementation — Transfers of expenditures between chapters coding: 4.00; 3.20; 2.56; 1.92; 1.28; 0.64; 0.00.
  - Carryover of unused funds coding: 4.00; 2.67; 1.33; 0.00.
- Selected overall scores (1994 and 2003-04) — overall score (2003-04):
  - Austria: 2.35
  - Estonia: 3.00
  - Luxembourg: 3.06
  - Sweden: 2.84
  - United Kingdom: 3.38
  - Spain: 2.07
  - Lithuania: 1.86
  - Italy: 2.07
  - Poland: 2.40
  - Portugal: 1.53
  - Slovakia (Slovak Republic): 0.98
  - Hungary: 0.92
- Figures time span referenced: "1991-2004" (Figure 1 title).

### III. Findings — War of Attrition and Political Fragmentation
- Institutional gap:
  - The gap between the maximum index value (4) and a country’s current index strongly predicts subsequent improvements.
  - Table 1 — Institutional gap coefficients (selected): 4.61 [4.02]***; 6.23 [3.85]***; 6.34 [3.92]***; 7.35 [4.38]***.
- Fiscal balance and dynamics:
  - A larger lagged primary budget surplus increases the probability of budgetary reforms; deficits delay reforms.
  - Table 1 — Primary balance coefficients (selected): 0.50 [1.90]*; 0.49 [1.76]*; 0.92 [2.93]***.
  - Authors describe a two-corner dynamic: small deficits (or surpluses) with good institutions, or large deficits with weak institutions; deficits → difficulty reforming → persistent deficits until crisis forces deficit reduction → institutions can be strengthened.
- Government fractionalization:
  - More fragmented government coalitions negatively affect reform probability; interaction with primary balance matters.
  - Table 1 — Fractionalization and interaction: Fractionalization (FRAC) reported as -2.09; -0.80 (no z-statistics in one report); Primary Balance*FRAC: -0.97 [1.92]*.
  - Interaction interpretation from figures:
    - Effective coefficient on fractionalization is statistically indistinguishable from zero when fiscal balance is in deficit.
    - When fiscal balance is about 3 percent of GDP, both upper and lower confidence bands lie below zero: fractionalization then exerts a statistically significant negative effect on reforms.
    - In fuller models, fractionalization may exert negative influence even before the primary balance reaches 2 percent of GDP.

### IV. Economic Shocks, Overheating, and Crisis Effects
- Misery index components and principal components:
  - Unemployment rate: raises likelihood of reforms (significant at the 10 percent level in many specifications).
  - Log (inflation): raises likelihood of reforms (significant at the 1 percent level in many specifications).
  - Current account surplus: negative sign (larger surplus reduces likelihood of reform); significance often at the 10 percent level.
  - Principal components:
    - Overheating: highly correlated with inflation and current account deficit (interpreted as unsustainable domestic demand).
    - Stagflation: strongly correlated with unemployment and modestly with inflation and current account deficit.
- Nonlinear crisis/threshold effects:
  - Overheating nonlinearity: defined as zero below the 75th percentile and equal to overheating values above; the overheating nonlinearity term has a positive sign with strong statistical significance.
  - Crisis dummy: 1 when overheating is over its 75th percentile, 0 otherwise; coefficient on crisis dummy is positive and significant.
  - Table 4 — selected coefficients:
    - Overheating Nonlinearity: 1.33 [2.22]**; 2.36 [2.77]***.
    - Crisis: 4.71 [2.05]**; 6.91 [2.45]**.
    - Overheating alone: mixed coefficients (e.g., 0.41 [1.05]; -0.46 [0.83]; 0.00 [0.01]).
- Table 3 — economic shocks (selected coefficients):
  - Institutional gap: 10.99 [2.75]***; 11.68 [2.55]**; 11.76 [2.67]***; 14.20 [2.52]**.
  - Primary balance: 1.42 [2.09]**; 1.41 [2.00]**; 1.41 [2.03]**; 1.85 [2.07]**.
  - Unemployment: 0.94 [1.84]*; 0.97 [1.80]*; 1.00 [1.90]*; 0.90 [2.26]**.
  - Log (inflation): 4.66 [2.91]***; 5.25 [2.83]***; 5.32 [2.92]***; 3.16 [2.43]**.
  - Current account Surplus: -0.30 [1.78]*; -0.29 [1.78]*; -0.24 [1.79]*.
  - Primary Balance*FRAC: -1.46 [2.00]**; -1.34 [1.97]**; -1.37 [2.01]**; -2.02 [2.16]**.

### V. Credibility, Ideology, and “Unlikely” Reformers
- Baseline ideology:
  - Political ideology by itself is not significant in noncrisis settings (e.g., “Rightist” ideology: -0.02 [0.11] in one specification).
- Interaction of ideology with overheating/crisis:
  - Overheating × “Rightist” ideology: Overheating positive and significant; interaction term negative and significant.
    - Table 5 — Overheating: 3.71 [2.36]**; Overheating*“Rightist” Ideology: -0.31 [1.97]**.
    - Interpretation: response to overheating is smaller the more “right wing” the government; at median “rightist ideology” index value 11, the effective coefficient on overheating is almost zero; at the 75th percentile (13.5), the response is negative.
  - Crisis × “Rightist” ideology:
    - Crisis coefficient (in one column): 45.79 [3.67]***.
    - Crisis*“Rightist” Ideology: -3.06 [3.75]***.
    - Interpretation: in a crisis, leftist governments are more likely to reform—evidence consistent with the “Nixon going to China” credibility hypothesis; effective crisis response strongest under leftist governments and falls as ideology moves rightward, becoming insignificant just beyond the 75th percentile of the ideology variable.
- Table 5 — other selected coefficients:
  - Institutional gap: 7.32 [4.73]***; 9.93 [3.10]***; 17.06 [4.43]***.
  - Primary balance: 0.91 [3.09]***; 1.12 [2.16]**; 1.29 [2.61]***.
  - Fractionalization (FRAC): -0.66 [0.30]; -4.43 [1.41]; -3.81 [1.11].
  - Primary Balance*FRAC: -0.96 [1.90]*; -1.27 [1.87]*; -1.55 [2.08]**.

### VI. Model Performance, Robustness, and Forecasts
- Table 6 — Predicted probabilities (model predictions vs actual):
  - Actual Reversal: Reversal 0.49; No change 0.51; Improvement 0.00; Large Improvement 0.00.
  - Actual No change: Reversal 0.04; No change 0.89; Improvement 0.06; Large Improvement 0.01.
  - Actual Improvement: Reversal 0.00; No change 0.38; Improvement 0.51; Large Improvement 0.11.
  - Actual Large improvement: Reversal 0.00; No change 0.06; Improvement 0.26; Large Improvement 0.68.
  - Totals (predicted): Reversal 0.06; No change 0.76; Improvement 0.12; Large Improvement 0.06.
- Robustness checks:
  - Results robust to leave-one-country-out tests and to alternative categorizations of improvement magnitudes.
  - Interaction effects and primary balance–fractionalization findings are reinforced in fuller specifications.

### VII. Conclusions and Policy Implications
- Two-cycle dynamic:
  - Virtuous cycle: good fiscal performance → easier reforms → stronger institutions → better fiscal outcomes.
  - Vicious cycle: deficits → weak institutions → persistent deficits.
- Role of economic pain and crises:
  - Economic distress, especially “overheating” (high inflation combined with large current account deficits), helps break political deadlock and raises the probability of reform.
  - Markets that “forgive” shocks may reduce external pressure and blunt crisis-induced reform incentives.
- Political leadership and credibility:
  - Strong, unified leadership can be necessary to break inertia; credible democratic leadership that persuades constituents can be an alternative to coercive means.
  - “Unlikely” reformers (leftist governments undertaking contractionary reforms in crisis) can gain credibility that facilitates difficult reforms; credibility-based reforms may be more inclusive and sustainable.
- Policy takeaways emphasized by the authors:
  - Strengthen fiscal positions in good times to create space for institutional reform.
  - Recognize that severe economic distress (overheating crises) can trigger reforms, but reliance on crises is neither desirable nor predictable.
  - Cultivate political credibility and leadership to build consensus for institutional reforms, particularly in fractionalized political environments.

*Source: _wp0882 - 2008 (IMF working paper content as provided in the supplied text).*

### 2008. Comments from Roel Beetsma, Jurgen von Hagen, and Dennis Quinn were most helpful.

### _wp0882 - 2008. Comments from Roel Beetsma, Jurgen von Hagen, and Dennis Quinn were most helpful.

### I. Introduction
- Literature shows strengthened institutional framework for the budget process can help improve fiscal discipline and performance; representative contributions include Alt and Lowry (1994), Poterba (1994), von Hagen and Harden (1995), Hallerberg and von Hagen (1999), and Alesina and others (1999).
- These authors find that checks and balances in the formulation and implementation of the budget are not a “veil” but have real effects on budget outcomes.
- Earlier findings relied on cross-sectional evidence and were open to the criticism that omitted determinants of fiscal outcomes may be correlated with budget institutions (rules and procedures of the budget process).
- The authors revisited the subject using within-country over-time variation and a wide variety of variables representing alternative hypotheses regarding mechanisms contributing to budget deficits (Fabrizio and Mody, 2006).
- The authors report: "We continue to find that strong budget institutions are associated with greater fiscal discipline even when the politics is unfavorable to such discipline."
- Principal contribution of the paper: it conducts, to the authors' knowledge, the first statistical examination of the determinants of budget reform, using time-series measures of the quality of budget institutions for 23 European economies during 1991-

### II. Data and Empirical Approach
- Listed in Contents: "II. Data and Empirical Approach" (page 6).
- Appendices include definitions and sources of variables used in regression analysis (Appendix II, page 19).

### III. The Setting: War of Attrition
- Listed in Contents: "III. The Setting: War of Attrition" (page 8).
- Table referenced: "Table 1. War of Attrition" (page 21).

### IV. Economic Shocks and Crises
- Listed in Contents: "IV. Economic Shocks and Crises" (page 10).
- Tables referenced: "Table 3 Economic Shocks" (page 22); "Table 4 Crises and Reforms" (page 23).

### V. Credibility: Does It Take Nixon To Go To China?
- Listed in Contents: "V. Credibility: Does It Take Nixon To Go To China?" (page 12).
- Table referenced: "Table 5 Credibility" (page 24).

### VI. Conclusions
- Listed in Contents: "VI. Conclusions" (page 13).
- The paper emphasizes the importance of understanding determinants of budget reform given the demonstrated role of budget institutions in fiscal outcomes.

### Appendices and Supporting Material (as listed)
- Appendix I: Quality of Budget Institutions (page 15).
  - Appendix Tables: Construction of the Index: Fiscal Institutions and Their Index Parameters (Table 1, page 16); Index of Quality of Budget Institutions (Table 2, page 17); Fiscal Institutions’ Quality Index (Table 3, page 18).
- Appendix II: Definitions and Sources of Variables Used in Regression Analysis (page 19).
- References (page 30).
- Figures (pages 25–29) include:
  - Figure 1. Average Value of Fiscal Institutions’ Index, 1991-2004.
  - Figure 2. Quality of Fiscal Institutions’ Index and Per Capita Income.
  - Figure 3. Fiscal Institutions’ Index.
  - Figure 4. Interaction of Primary Balance and Fractionalization.
  - Figure 5. Nonlinear Effects in the Full Model.

### Key statistics and exact data points (as presented)
- Sample: "23 European economies during 1991-" (text cutoff; presented exactly as in source).
- Time span referenced in figures: "1991-2004" (Figure 1 title).

*Source: _wp0882 - 2008. Comments from Roel Beetsma, Jurgen von Hagen, and Dennis Quinn were most helpful.*

### 2004. We use this setting also to conduct a broader investigation of the political economy of

### _wp0882 - 2004. We use this setting also to conduct a broader investigation of the political economy of

### Theoretical background
- Three relevant themes in the literature:
  - Inertia in policy and the “war of attrition” among interest groups (Shepsle and Weingast, 1981; Weingast, Shepsle, and Johnson, 1981; Alesina and Drazen, 1991).
  - Crisis as an instigator of reform (Rodrik, 1996; Drazen and Easterly, 2001; Alesina, Ardagna, and Trebbi, 2006).
  - Government ability to act and credibility considerations, including the “Nixon going to China” hypothesis (Cukierman and Tommasi, 1998).
- Key theoretical implications emphasized by the authors:
  - Healthy public finances reduce the cost of conceding and facilitate reform; fractionalized governments slow reform.
  - Crises can dissolve distributional certainties and allow reform coalitions to form.
  - Strong, unified governments are more likely to undertake measures in a crisis, but credibility can allow democracies to achieve reforms without overriding legitimate opposition.

### Data and empirical approach
- Index construction and sample:
  - Index of budget institutions’ quality constructed over the period 1994-2004 for 23 European countries.
  - The index ranges from zero to four.
  - The index is built across three stages of the budgetary process: preparation, authorization, and implementation, using features such as: fiscal rules, budget parameters and norms, dominance of finance/prime minister in negotiation, limits on amendments, sequence of legislative decisions, balance of executive and parliament, firmness in execution, and procedures for unforeseen adjustments.
  - Sources: annual fiscal budget laws, IMF ROSC Fiscal Transparency Module, Hallerberg, Strauch, and von Hagen (2007), with direct consultation of country authorities where needed.
- Dependent variable and sample size:
  - Dependent variable: change in budget institutions two years ahead (categorized into four groups: a large improvement, an improvement, no change, and a setback).
  - Sample: 102 observations initially, with most (78 of the 102) associated with no change in institutional quality; 12 observations associated with strengthening up to 0.7 point (designated “an improvement”); 6 observations with strengthening larger than 0.7 (designated “a large improvement”); 6 observations with an institutional setback.
  - After addressing overlapping two-year projections and missing values, the analysis uses about 100 observations.
- Methodology:
  - Ordered logit regressions with robust standard errors.
  - Inclusion of an “institutional gap” variable equal to (4 − country index) to capture scope for improvement.
  - Year and country fixed effects included throughout.

### Findings: war of attrition and political fragmentation
- Institutional gap:
  - The gap between the highest possible institutional quality (value four) and the country’s state of fiscal institutions strongly determines the scope of subsequent improvements.
- Fiscal balance and the war of attrition:
  - A larger lagged primary budget surplus increases the probability of budgetary reforms; a deficit delays reforms.
  - Countries tend to move to two corner outcomes: small fiscal deficits (surpluses) with good institutions, or large deficits with weak institutions.
  - The dynamic: deficit → difficulty reforming institutions → persistent deficits until a crisis forces deficit reduction → then institutions can be strengthened.
- Government fragmentation (fractionalization):
  - More fragmented government coalitions negatively affect reform probability; the direct effect is not always statistically significant.
  - Interaction effect: fractionalization reduces the positive effect of a larger primary balance on reforms.
  - Figure-based thresholds from interaction analysis:
    - The effective coefficient on fractionalization is statistically indistinguishable from zero when fiscal balance is in deficit.
    - When fiscal balance is about 3 percent of GDP, both upper and lower confidence bands lie below zero: fractionalization then exerts a statistically significant negative effect on reforms.
    - In fuller models, fractionalization may exert negative influence even before the primary balance reaches 2 percent of GDP.

### Economic shocks, overheating, and crises
- Misery index components:
  - Unemployment rate (significant at the 10 percent level) and log of the inflation rate (significant at the 1 percent level) both raise likelihood of reforms.
  - Current account surplus: negative sign (larger surplus reduces likelihood of reform); significance at the 10 percent level.
- Nonlinear crisis effects:
  - Principal components constructed from unemployment, log inflation, and current account deficit:
    - “Overheating”: highly correlated with inflation and current account deficit (interpreted as unsustainable domestic demand).
    - “Stagflation”: tightly correlated with unemployment, modestly with inflation and current account deficit.
  - Overheating by itself: positive but not always significant.
  - Nonlinear response test:
    - Define an “overheating, nonlinearity” variable that is zero below the 75th percentile and equals overheating values thereafter.
    - The overheating nonlinearity term has a positive sign with strong statistical significance, indicating a sharp threshold effect.
  - Crisis dummy:
    - Crisis dummy = 1 when overheating is over its 75th percentile, 0 otherwise.
    - Coefficient on crisis dummy is positive and significant, with or without stagflation included.
  - Interpretation: when overheating crosses a threshold (top quartile), the likelihood of reform significantly increases.

### Credibility, ideology, and the “unlikely” reformer
- Baseline ideology effects:
  - Political ideology by itself is not significant in noncrisis settings.
- Interaction of ideology and overheating/crisis:
  - Interaction of overheating with “rightist ideology”:
    - Overheating alone: positive and significant.
    - Interaction term (overheating × rightist ideology): negative and significant → response to overheating is smaller the more “right wing” the government.
    - At median “rightist ideology” index value 11, the effective coefficient on overheating is almost zero; at the 75th percentile (13.5), the response is negative.
  - Interaction of crisis dummy with ideology:
    - Crisis dummy positive and significant.
    - Interaction between crisis dummy and rightist ideology is negative and highly significant.
    - In absence of crisis: rightist governments may be more prone to reform (positive coefficient on rightist ideology).
    - In a crisis: leftist governments are more likely to reform — evidence consistent with the “Nixon going to China” credibility hypothesis.
  - Effective crisis response varies with ideology: strongest under leftist governments; response falls as ideology moves rightward and becomes insignificant just beyond the 75th percentile of the ideology variable.
- Robustness checks:
  - Interaction effects and primary balance–fractionalization findings are reinforced in fuller specifications.
  - Forecasts from the model match actual changes reasonably well (Table 6).
  - Results robust to leave-one-country-out tests and to alternative categorizations of improvement magnitudes.

### Conclusions and policy implications
- Two-cycle dynamic:
  - Countries can enter a fiscally “virtuous” cycle (good fiscal performance → easier reforms → stronger institutions → better fiscal outcomes) or a “vicious” cycle (deficits → weak institutions → persistent deficits).
- Role of economic pain:
  - Economic distress, especially “overheating” (high inflation combined with large current account deficits), helps break political deadlock and raises the probability of reform.
  - Markets that “forgive” shocks may reduce external pressure and thus blunt crisis-induced reform incentives.
- Political leadership and credibility:
  - Forward-looking and strongly unified leadership can be necessary to break inertia; however, credible democratic leadership that persuades constituents can be an alternative to coercive means.
  - In crises, “unlikely” reformers (leftist governments undertaking fiscally contractionary reforms) can gain credibility that facilitates difficult reforms; such credibility-based reforms may be more inclusive and sustainable.
- Policy takeaways emphasized by the authors:
  - Strengthen fiscal positions in good times to create space for institutional reform.
  - Recognize that severe economic distress (overheating crises) can trigger reforms, but reliance on crises is neither desirable nor predictable.
  - Cultivate political credibility and leadership that can build consensus for institutional reforms, particularly in fractionalized political environments.

*Source: IMF working paper content as provided in the supplied text.*

### Appendix I: Quality of Budget Institutions

### Appendix I: Quality of Budget Institutions

### Construction of the index
- Sample: 23 European countries — Austria, Belgium, Bulgaria, the Czech Republic, Denmark, Estonia, Finland, Germany, Greece, Hungary, Italy, Latvia, Lithuania, Luxembourg, the Netherlands, Poland, Portugal, Romania, the Slovak Republic, Slovenia, Spain, Sweden, and the United Kingdom.
- Purpose: A quantitative index consolidating objective features of the budget process; a larger value implies more checks and balances.
- Three phases of the budget process are indexed:
  - Preparation stage (when the budget is drafted) — weight: 0.33
  - Authorization stage (draft budget approved and formalized) — weight: 0.33
  - Implementation stage (budget executed and may be modified or amended) — weight: 0.33
- Index construction follows Fabrizio and Mody (2006) and Hallerberg, Strauch, and von Hagen (2007).

### Components and coding (selected items and coding values)
- Preparation (examples of components and assigned values)
  - General constraint — weight: 0.33
    - Spending and debt as share of GDP: 4.00
    - Spending as share of GDP or golden rule or limit on public borrowing: 3.00
    - Balance and debt as share of GDP: 2.00
    - Balance as share of GDP: 1.00
    - None: 0.00
  - Agenda setting — weight: 0.33
    - MF or PM determines budget parameters to be observed by spending ministers: 4.00
    - MF proposes budget norms to be voted on by cabinet: 3.00
    - Cabinet decides on budget norms first: 2.00
    - MF or cabinet collects bids subject to the pre-agreed guidelines: 1.00
    - MF or cabinet collects bids from spending ministers: 0.00
  - Structure of negotiations — weight: 0.33
    - Finance ministry holds bilateral negotiations with each spending ministry: 4.00
    - Finance ministry holds multilateral negotiations: 2.00
    - All cabinet members are involved in the negotiations at the same time: 0.00
- Authorization (examples)
  - Parliamentary amendments of the budget — weight: 0.33
    - Are not allowed, or required to be offsetting: 4.00
    - Do not required to be offsetting: 0.00
  - Sequence of votes — weight: 0.33
    - Initial vote on total budget size or aggregates: 4.00
    - Final vote on budget size or aggregates: 0.00
  - Relative power of the executive vis-à-vis the parliament; can cause fall of government? — weight: 0.33
    - Yes: 4.00
    - No: 0.00
- Implementation (selected coding and weights)
  - Overall implementation stage weight: 0.33
  - Changes in the budget law during execution — subweight: 0.25
    - Only new budgetary law to be passed under the same regulations as the ordinary budget: 4.00
    - Requires parliament consent: 2.00
    - At total or large discretion of government: 0.00
  - Transfers of expenditures between chapters (i.e., ministries' budgets) — subweight: 0.25
    - Not allowed: 4.00
    - Only possible within departments with MF consent: 3.20
    - Only possible within departments: 2.56
    - Require approval of parliament: 1.92
    - Only if provided for in initial budget or with MF approval: 1.28
    - Limited: 0.64
    - Unlimited: 0.00
  - Carryover of unused funds to next fiscal year — subweight: 0.25
    - Not permitted: 4.00
    - Limited and required authorization by the MF or parliament: 2.67
    - Limited: 1.33
    - Unlimited: 0.00
  - Procedure to react to a deterioration of the budget deficit (due to unforeseen revenue shortfalls or expenditure increase) — subweight: 0.25
    - MF can block expenditures: 4.00
    - MF cannot block expenditures: 0.00

### Data sources and availability
- Data sources: annual fiscal budget laws, Reports on the Observance of Standards and Codes (ROSC) Fiscal Transparency Module (IMF), and direct contact with countries’ authorities.
- The appendix provides three tables:
  - Table A1: Components of the index (construction parameters and weighting factors).
  - Table A2: Index of Quality of Budget Institutions — scores by country for 1994 and 2003-04 at the Preparation, Authorization, Implementation stages and overall.
  - Table A3: Two snapshots (1994 and 2003 or 2004) of the budgetary quality and ranks (rank 1 highest = 23).
- Note: Data for the new Member States are available until 2003.

### Index results — selected overall scores (1994 and 2003-04)
- Austria — overall score (2003-04): 2.35
- Estonia — overall score (2003-04): 3.00
- Luxembourg — overall score (2003-04): 3.06
- Sweden — overall score (2003-04): 2.84
- United Kingdom — overall score (2003-04): 3.38
- Spain — overall score (2003-04): 2.07
- Lithuania — overall score (2003-04): 1.86
- Italy — overall score (2003-04): 2.07
- Poland — overall score (2003-04): 2.40
- Portugal — overall score (2003-04): 1.53
- Slovakia (Slovak Republic) — overall score (2003-04): 0.98
- Hungary — overall score (2003-04): 0.92
- Notes: Table A2 presents stage-by-stage scores and overall scores for each country for 1994 and 2003-04; Table A3 presents rankings for 1994 and 2003-04 (higher rank indicates better quality, highest rank = 23).

### Presentation and ancillary notes
- Scores and coding values are presented with decimal precision exactly as in the source (e.g., 4.00, 3.20, 2.56, 2.67).
- Sources cited within the appendix: Fabrizio and Mody (2006); Hallerberg, Strauch, and von Hagen (2007); and authors' calculations.

*Source: Appendix I, "Quality of Budget Institutions," authors' calculations; Tables A1–A3 as provided in the source document.*

### Appendix I

### _wp0882 - Appendix I

### Variable definitions
- Primary balance: The primary budget balance/GDP in t-1. (IMF, World Economic Outlook)
- Fractionalization: Measure of the distribution of parties in the government’s coalition, represented by the Herfindahl index, [1-[∑s_i]], where s_i is the share of party “i” in the coalition in year t. (Parties and Elections in Europe; Elections Around the World)
- Election year: A dummy variable taking the value 1 if an election occurred at time t.
- Political constraints: The political constraint index (POLCON): measure of veto players at time t, a higher value representing more constraints. (www-management.wharton.upenn.edu/henisz/)
- “Rightist” ideology: An index of ideology at time t, taking values from [5 to 16], with higher values representing a more “rightist” world view. (Benoit and Laver, 2006)
- Unemployment: The country’s unemployment rate at time t. (IMF, World Economic Outlook)
- Log (inflation): The log of the country’s [consumer price] inflation rate at time t. (IMF, World Economic Outlook)
- Current account surplus: The country’s current account surplus at time t. (IMF, World Economic Outlook)
- Excessive deficit procedure dummy: A dummy taking the value 1 if the country was subject to the [European Union’s] Excessive Deficit Procedure.
- Euro adoption dummy: A dummy taking the value 1 in the year the country adopted the euro and thereafter.
- Trade/GDP: [Exports+Imports]/GDP at time t. (IMF, World Economic Outlook)
- Overheating: First principal component of the unemployment rate, log (inflation), and the current account surplus. Larger values imply a combination of larger current account deficits and higher inflation. (Authors’ construction)
- Overheating (binary): Takes the values of the overheating variable above the 75th percentile and zero below that; intended to allow for nonlinearity in policy response to overheating. (Authors’ construction)
- Crisis: Takes the value 1 if the overheating variable is above its 75th percentile and zero otherwise. (Authors’ construction)
- Stagflation: Second principal component of the unemployment rate, log (inflation), and the current account surplus; strongly correlated with the unemployment rate and more modestly with inflation and the current account deficit. (Authors’ construction)

### Table 1 — War of Attrition: key coefficients (Dependent Variable: Institutional Reform)
- Institutional gap: 4.61 [4.02]***; 6.23 [3.85]***; 6.34 [3.92]***; 7.35 [4.38]***
- Primary balance: 0.50 [1.90]*; 0.49 [1.76]*; 0.92 [2.93]***
- Fractionalization (FRAC): -2.09; -0.80 (reported with no z-statistics shown)
- Primary Balance*FRAC: -0.97 [1.92]*
- Observations: 102 (for all columns)
- Pseudo R-squared: 0.39; 0.44; 0.45; 0.48
- Notes: Robust z statistics in brackets; * significant at 10 percent; ** significant at 5 percent; *** significant at 1 percent.

### Table 2 — Political Constraints: key coefficients (Dependent Variable: Institutional Reform)
- Institutional gap: 7.33 [4.25]***; 7.36 [4.41]***; 7.30 [4.53]***
- Primary balance: 0.92 [2.98]***; 0.92 [2.91]***; 0.91 [3.05]***
- Fractionalization (FRAC): -0.76 [0.42]; -0.80 [0.42]; -0.62 [0.29]
- Primary Balance*FRAC: -0.99 [1.99]**; -0.97 [1.90]*; -0.98 [1.95]*
- Election year: -0.54 [0.54] (reported in columns where included)
- Political constraints: -0.23 [0.04]; -0.15 [0.02] (reported where included)
- “Rightist” ideology: -0.02 [0.11] (in one column)
- Observations: 102 (for all columns)
- Pseudo R-squared: 0.48 (for all columns)

### Table 3 — Economic Shocks: key coefficients (Dependent Variable: Institutional Reform)
- Institutional gap: 10.99 [2.75]***; 11.68 [2.55]**; 11.76 [2.67]***; 14.20 [2.52]**
- Primary balance: 1.42 [2.09]**; 1.41 [2.00]**; 1.41 [2.03]**; 1.85 [2.07]**
- Fractionalization (FRAC): -0.17 [0.06]; -1.38 [0.48]; -1.41 [0.49]; -1.50 [0.55]
- Primary Balance*FRAC: -1.46 [2.00]**; -1.34 [1.97]**; -1.37 [2.01]**; -2.02 [2.16]**
- Unemployment: 0.94 [1.84]*; 0.97 [1.80]*; 1.00 [1.90]*; 0.90 [2.26]**
- Log (inflation): 4.66 [2.91]***; 5.25 [2.83]***; 5.32 [2.92]***; 3.16 [2.43]**
- Current account Surplus: -0.30 [1.78]*; -0.29 [1.78]*; -0.24 [1.79]*
- Excessive deficit Procedure dummy: -2.55 [1.13]; -2.80 [1.26] (in some columns)
- Euro adoption Dummy: 4.37 [1.60] (reported where included)
- Trade/GDP: 0.09 [1.45] (reported where included)
- Observations: 102; 100; 100; 100 (across columns)
- Pseudo R-squared: 0.54; 0.56; 0.56; 0.60

### Table 4 — Crises and Reforms: key coefficients (Dependent Variable: Institutional Reform)
- Institutional gap: 7.27 [4.01]***; 8.00 [4.49]***; 14.45 [2.05]**; 8.22 [4.01]***; 12.38 [3.13]***
- Primary balance: 0.86 [2.52]**; 0.96 [2.32]**; 1.61 [2.09]**; 0.97 [2.63]***; 1.57 [2.53]**
- Fractionalization (FRAC): -1.00 [0.42]; -0.90 [0.32]; -1.07 [0.43]; -0.37 [0.16]; -0.45 [0.21]
- Primary Balance*FRAC: -0.95 [1.87]*; -1.05 [1.74]*; -1.25 [2.02]**; -1.02 [1.85]*; -1.31 [2.06]**
- Overheating: 0.41 [1.05]; -0.46 [0.83]; 0.00 [0.01] (in different columns)
- Overheating Nonlinearity: 1.33 [2.22]**; 2.36 [2.77]***
- Crisis: 4.71 [2.05]**; 6.91 [2.45]**
- Stagflation: 2.24 [1.56]; 1.55 [2.20]**
- Observations: 100; 100; 100; 102; 100
- Pseudo R-squared: 0.49; 0.52; 0.60; 0.52; 0.58

### Table 5 — Credibility: key coefficients (Dependent Variable: Institutional Reform)
- Institutional gap: 7.32 [4.73]***; 9.93 [3.10]***; 17.06 [4.43]***
- Primary balance: 0.91 [3.09]***; 1.12 [2.16]**; 1.29 [2.61]***
- Fractionalization (FRAC): -0.66 [0.30]; -4.43 [1.41]; -3.81 [1.11]
- Primary Balance*FRAC: -0.96 [1.90]*; -1.27 [1.87]*; -1.55 [2.08]**
- “Rightist” ideology: -0.02 [0.11]; 0.32 [1.11]; 0.41 [1.81]*
- Overheating: 3.71 [2.36]** (included in one column)
- Overheating*“Rightist” Ideology: -0.31 [1.97]**
- Crisis: 45.79 [3.67]*** (in one column)
- Crisis*“Rightist” Ideology: -3.06 [3.75]***
- Observations: 102; 100; 102
- Pseudo R-squared: 0.48; 0.52; 0.60

### Table 6 — Model Predictions (Predicted Probability of Change)
- Actual Reversal: Reversal 0.49; No change 0.51; Improvement 0.00; Large Improvement 0.00
- Actual No change: Reversal 0.04; No change 0.89; Improvement 0.06; Large Improvement 0.01
- Actual Improvement: Reversal 0.00; No change 0.38; Improvement 0.51; Large Improvement 0.11
- Actual Large improvement: Reversal 0.00; No change 0.06; Improvement 0.26; Large Improvement 0.68
- Totals (predicted): Reversal 0.06; No change 0.76; Improvement 0.12; Large Improvement 0.06

### Figures — data summaries and visual findings
- Figure 1: Average Value of Fiscal Institutions' Index, 1991-2004 — shows trajectories for New EU members and Old EU members; higher rank indicates better quality (highest rank=23). Data for new Member States available until 2003.
- Figure 2: Quality of Fiscal Institutions' Index and Per Capita Income — scatter plots for 1994 and 2003 showing per capita income (U.S. dollar) against fiscal institutions' index; higher rank indicates better quality (highest rank=23). Data for new Member States available until 2003.
- Figure 3: Fiscal Institutions' Index, 1994-2003 — plot of fiscal institutions' index in 1994 versus 2003; higher rank indicates better quality (highest rank=23).
- Figure 4: Interaction of Primary Balance and Fractionalization — displays Effective Coefficient of Fractionalization and Effective Coefficient of Primary Balance with Lower Bound and Upper Bound plotted against Primary Balance and Fractionalization, respectively.
- Figure 5: Nonlinear Effects in the Full Model
  - Interaction of Primary Balance and Fractionalization: Effective Coefficient of Fractionalization plotted against Primary Balance with Lower Bound and Upper Bound.
  - Interaction of Economic Overheating and Political Ideology: Effective Coefficient of Crisis plotted against Rightist Ideology with Lower Bound and Upper Bound.

*Source: _wp0882 - Appendix I*

### References

### References

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*Source: _wp0882 - References (PDF chapter/section).*

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