A developed fiscal framework is based on several fiscal institutions that contribute to fiscal and macroeconomic performance: a formal process of government budget planning, congressional discussion and approval, execution, and accountability; fiscal rules; sovereign wealth funds; and fiscal councils.
1. World Distribution of Fiscal Rules
Since the 1990s adoption of fiscal rules started is spreading around the world, as part of significant reforms of fiscal frameworks undertaken by many industrial and emerging/developing countries. As of 2015, 78 countries have at least one type of national fiscal rule in place. Fiscal rules are quantitative targets (often ceilings, sometimes floors) on levels, GDP-ratios or growth rates of government budget balance, debt, expenditure, and/or revenue.
2. Fiscal Rule Policy Objectives
Fiscal rules are adopted to strengthen one or several key policy objectives: macroeconomic stabilization, fiscal sustainability and solvency, and limiting the size of government. Macroeconomic stability is enhanced by counter-cyclical government expenditure, which could be achieved by a budget balance rule (BBR), a debt rule (DR) or an expenditure rule (ER). Fiscal sustainability and solvency are strengthened by limiting government deficit and debt levels, which could be achieved by any of the four rules. Limiting the size of government is reflected in putting ceilings on expenditure or revenue levels, which is pursued by an ER or a RR.
Whatever their particular form, fiscal rules are potentially efficient tools to contribute to fiscal sustainability and solvency. However, rules can be inefficient in attaining macroeconomic stabilization. For instance, specific forms of a BBR can be at odds with counter-cyclical stabilization. A BBR defined as a budget balance target ratio to current GDP (the Maastricht Treaty rule), which is invariant to cyclical conditions, induces pro-cyclicality of government expenditure. A BBR defined as a structural budget balance ratio to GDP induces a-cyclicality of government expenditure. However, a BBR defined as an average budget balance ratio to GDP over the cycle (allowing pro-cyclical budget balance deviations), induces counter-cyclicality of government expenditure.
3. Determinants of Adopting Fiscal Rules
While many countries have adopted fiscal rules, a majority still does not have rules in place. Under which conditions do countries adopt rules and maintain them over time? This question has been addressed empirically by the literature on fiscal rules. Institutional and political conditions (democracy, federalism, checks and balances, and government stability) contribute significantly to the likelihood of having a fiscal rule in place. Fixed exchange rate regimes do not contribute to explaining rules but an inflation targeting regime does. Capital account openness and financial development contribute to having a fiscal rule. Countries that are richer are more likely and those with an older population are less likely to have fiscal rules. Finally, fiscal performance also co-determines adoption of fiscal rules: the level of the government budget balance raises and government expenditure pro-cyclicality lowers the likelihood of having a rule in place.
4. Effects of Fiscal Rules on Macroeconomic and Fiscal Performance
A review of the empirical literature on the effects of fiscal rules on macroeconomic and fiscal performance reveals significant positive effects of different measures of fiscal rules (aggregate or any rule, particular rules, Maastricht Treaty rules) on per capita GDP levels and growth rates. Fiscal rules raise the standard deviation of per capita GDP growth but reduce it when rules are interacted with a measure of discretionary fiscal policy. Several studies report positive and significant effects of different measures and types of fiscal rules on different measures of the budget balance. Government debt levels are not affected by fiscal rules.
Results on the effects of fiscal rules on fiscal policy cyclicality are mixed. In most cases, different fiscal rules do not affect the cyclical correlation between the government budget and GDP or between government expenditure and GDP. The exception is the expenditure rule, which reduces the cyclical correlation between government expenditure and GDP, hence turning fiscal policy more counter-cyclical. Rules reduce government bond spreads.
More recent empirical research tests for the contribution of fiscal rules to fiscal-policy performance in a large world sample. This study estimates the effects of three types of rules – ERs, BBRs, and DRs, using de facto and de jure measures – on four indicators of fiscal performance – cyclicality of government expenditure and fiscal balance, and levels of fiscal balance and government debt –, and controlling for 13 other determinants. While neither a BBR nor a DR have a statistically significant effect on the pro-cyclicality of government expenditure, the latter is significantly reduced by the presence of an ER. Regarding fiscal solvency, the level of the fiscal balance is significantly raised by the presence of any rule: a BBR, a DR or an ER.
5. Conclusions
Fiscal rules are increasingly adopted in both emerging/developing economies and industrial countries. Their growing popularity stems from their potential contribution to macroeconomic stability, fiscal sustainability and solvency, and the limits to government size. Rules come in all types and shapes: they target different fiscal aggregates, they are defined for different fiscal and output measures (current or structural, annual or multi-year), and they are not always enforced (e.g., the frequent violation of Maastricht Treaty limits on government debt and deficit ratios to GDP). Depending on their precise form, they could stabilize or de-stabilize an economy. However, in principle all types of fiscal rules potentially strengthen fiscal solvency and limit the size of government.
Empirical world evidence suggests that a wide set of political, structural, economic, and fiscal conditions explain why some countries adopt fiscal rules, while others do not (yet). On the reverse causality, which focuses on the contribution of fiscal rules to macroeconomic and fiscal performance, international evidence suggests that rules – controlling for other determinants – raise GDP levels and growth rates and improve several measures of fiscal performance. More recent and systematic world evidence shows that expenditure rules reduce pro-cyclicality of government expenditure. Regarding fiscal solvency, the level of the fiscal balance is significantly raised by the presence of any fiscal rule.
Universidad del Desarrollo, Chile. I thank Martín Carrasco and Isaac Martínez for excellent research assistance.
For bio of the author see the bios at the end of the book.
