Fiscal rules and budget forecast errors of Italian Municipalities

We study the impact of the domestic stability pact on the budget forecast errors of Italian municipalities. The identification of the causal effect exploits a quasi-natural experiment generated by the removal in 2001 of the fiscal restraints on budget decisions for municipalities with less than 5,000 inhabitants and by stricter budgetary restrictions and severe penalties for noncompliers in 2002. We find that relaxing fiscal rules had a sizeable impact on budget forecast errors, especially in 2002. Revenue (expenditure) forecast errors for municipalities below 5,000 inhabitants became indeed 26% (22%) larger than in the past.