Chile’s fiscal rule has served the country well, helped strengthen fiscal discipline and medium-term planning, and contributed to both building buffers ahead of the Global Financial Crisis (GFC) and keeping debt low by international standards. In addition, the fiscal rule is very well regarded internationally and has been considered a model to emulate by many countries. Nonetheless, in light of the decade-and-a-half experience with the fiscal rule, as well as the upward trajectory of public debt, this analysis aims to provide a fresh assessment of the fiscal rule’s effectiveness and explore scope for further improvement.
When trying to provide an assessment, it is helpful to set the stage by looking at the two main standard objectives of fiscal rules: macroeconomic stabilization, by reducing procyclicality of expenditure, and ensuring fiscal sustainability and preservation of net wealth. In the context of Chile, the stabilization objective refers mainly to fluctuations of the fiscal balance around the structural balance target, while sustainability is mainly linked to the choice of level for the structural balance target. In addition, it is generally desirable for fiscal rules to be simple, transparent, resilient, easy to monitor and enforce, and able to provide operational guidance for the annual budget process.
Chile’s fiscal rule has provided substantial correction for copper and business cycles, which have been strongly correlated among themselves (see Figure 1). As desired, the fiscal balance has tended to follow the cycles, while the structural balance has been much smoother, thereby implying considerable cyclical adjustment. In turn, real expenditure has shown countercyclical behavior mainly during the GFC, and somewhat afterwards, though not in the early period.
Fiscal Balance, Structural Balance, Copper, Output & Cyclical Adjustment
(In percent GDP)
Sources: DIPRES, Central Bank of Chile, Bloomberg, and IMF staff calculations.Fiscal Balance, Structural Balance, Copper, Output & Cyclical Adjustment
(In percent GDP)
Sources: DIPRES, Central Bank of Chile, Bloomberg, and IMF staff calculations.Fiscal Balance, Structural Balance, Copper, Output & Cyclical Adjustment
(In percent GDP)
Sources: DIPRES, Central Bank of Chile, Bloomberg, and IMF staff calculations.When decomposing the structural balance into targets and deviations (see Figure 2), one can see two features. First, the mild countercyclicality of the structural balance has been only slightly due to setting the target (mostly around the GFC), but mainly due to deviations from the target (particularly in 2008–13 and 2016–17). Were target changes essential for countercyclicality? Not necessarily: the international best practice suggests that it is better to link the structural balance targets to long-term objectives, and implement essential countercyclical policy via escape clauses, to enhance credibility. Second, there was a persistent downward shift in structural balance targets after the GFC: addressing cyclicality was not the main reason for changing targets, which points to the need to anchor the targets to long-term objectives, such as trend of potential growth and debt sustainability.
Structural Balance, SB Targets and Deviations, Copper and Output
Sources: Dipres and IMF staff calculations.Note: No official targets were set for 2011–2014. SB targets are based on what is stated in Informe de Finanzas Públicas.Structural Balance, SB Targets and Deviations, Copper and Output
Sources: Dipres and IMF staff calculations.Note: No official targets were set for 2011–2014. SB targets are based on what is stated in Informe de Finanzas Públicas.Structural Balance, SB Targets and Deviations, Copper and Output
Sources: Dipres and IMF staff calculations.Note: No official targets were set for 2011–2014. SB targets are based on what is stated in Informe de Finanzas Públicas.While the cyclical adjustment has been considerable, the behavior of its two components has been quite different. First, the output adjustment has been asymmetric (see Figure 3), presenting a spending bias, as the ex-ante potential output chosen by the expert committee has turned out to be consistently above actual output in all years but 2012, persistently showing over-optimism and implying positive output gaps. This implied higher structural revenues and hence more room for spending than if the output gap were on average zero. Second, the copper adjustment has been the main driver of fiscal savings in the early period, and has provided extra spending room when copper prices were deemed to be below their long-term level. This is less likely going forward, as copper production costs have been increasing.
Output Growth and Cyclical Adjustment to Output
Sources: DIPRES, Central Bank of Chile and IMF staff calculations.Output Growth and Cyclical Adjustment to Output
Sources: DIPRES, Central Bank of Chile and IMF staff calculations.Output Growth and Cyclical Adjustment to Output
Sources: DIPRES, Central Bank of Chile and IMF staff calculations.The analysis finds that the one-sided cyclical adjustment for output has accounted for virtually the entire contribution of the cumulative primary deficits (8 percent of GDP) to the increase in debt over the past 10 years. Deviations from the structural balance targets have not been a culprit of the debt increase in Chile, as they have tended to cancel out. Neither have been the fiscal projections, as they have not been overly optimistic on average. The analysis concludes by inviting the public to explore the possibilities for: introducing an explicit medium-term anchor; setting the targets in a more structured way and linking them to long-term objectives; defining formal escape clauses for countercyclical purposes; and establishing formal adjustment rule for past deviations from targets.
