A nonlinear principal component analysis of the relationship between budget rules and fiscal performance in the European Union

Tests of the relationship between budget rules and fiscal performance are metric sensitive and arbitrary in the evaluation of the stringency of the rules, in the aggregation of these evaluations in an index and in the imposition of a linearly specified model. We propose a nonlinear principal component analysis to solve these problems and evaluate the relative disciplinary power of each rule. A battery of panel regressions on 1980–2003 optimally transformed data relative to 12 EU countries confirms that, upon controlling for standard economic, political and institutional variables, more stringent rules reduce fiscal imbalances and budget size.