When is fiscal adjustment an illusion?

Fiscal adjustment is an illusion when it lowers the budget deficit or publi c debt but leaves government net worth unchanged. Conventional measures of the budget deficit largely show the change in public sector debt. Ideally, the measured deficit would reflect the change in Public sector net worth. M any people consider it impractical to try to measure public sector assets. My paper does not discuss what the deficit should measure, but instead prop oses a positive and testable theory of how governments actually behave. When an outside agent forces a reduction in a government's conventional def icit and debt accumulation, the government responds by lowering asset accum ulation or increasing hidden liabilities. Since government net worth is unc hanged, such fiscal adjustment is an illusion. Using data from countries wi th World Bank and IMF fiscal adjustment programmes, and case studies of EMU countries' compliance with the Maastricht criteria, I confirm my theoretic al predictions: fiscal adjustment in these countries was at least partly an illusion.