Front Matter

Front Matter

International Monetary Fund. Western Hemisphere Dept.
Felipe Larraín, Luca Ricci, Klaus Schmidt-Hebbel, Hermann González, Metodij Hadzi-Vaskov, and Andrés Pérez
Published Date:
October 2019
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Enhancing Chile’s Fiscal Framework

Lessons from Domestic and International Experience


Felipe Larram

Luca Antonio Ricci

Klaus Schmidt-Hebbel


Hermann González

Metodij Hadzi-Vaskov

Andrés Pérez


Enhancing Chile’s Fiscal Framework

Lessons from Domestic and International Experience


Felipe Larram

Luca Antonio Ricci

Klaus Schmidt-Hebbel


Hermann González

Metodij Hadzi-Vaskov

Andrés Pérez


© 2019 International Monetary Fund

Cover design: Winking Fish

Composition: AGS, An RR Donnelley Company

Cataloging-in-Publication Data

IMF Library

Names: Larraín, Felipe, editor. | Ricci, Luca Antonio, editor. | Schmidt-Hebbel, Klaus, editor. | International Monetary Fund, publisher.

Title: Enhancing Chile’s Fiscal Framework: Lessons from Domestic and International Experience / editors: Felipe Larraín, Luca Antonio Ricci, Klaus Schmidt-Hebbel / co-editors: Hermann González, Metodij Hadzi-Vaskov, Andrés Pérez.

Description: Washington, DC : International Monetary Fund, 2019. | Includes bibliographical references.

Identifiers: ISBN 9781513514024 (paper)

Subjects: LCSH: Fiscal policy—Chile. |

Classification: LCC HC141.P38 2019

DISCLAIMER: The views expressed in this book are those of the authors and do not necessarily represent the views of the IMF’s Executive Directors, its management, or any of its members.

ISBN: 978–1–51351–402–4 (English paper)

For more information, please visit the Chilean Ministry of Finance’s website at:

Please send orders to:

International Monetary Fund, Publication Services

P.O. Box 92780, Washington, D.C. 20090, U.S.A.

Tel.: (202) 623–7430 Fax: (202) 623–7201




This volume is the outcome of a conference organized by the Ministry of Finance of Chile and the IMF’s Western Hemisphere Department in January 2019 in Santiago, Chile. The editors and co-editors would like to thank all the presenters and participants in the conference for providing insightful contributions as well as to Ana Farren, Carolina Abuauad, and Aníbal Alarcón, who provided excellent support in organizing the event. The editors also acknowledge very fruitful discussions with Alejandro Werner, Patricia Alonso-Gamo, Catherine Pattillo, Paulo Medas, Luc Eyraud, and Alex Ho. The editors and co-editors express their appreciation to Jeff Hayden, Joe Procopio, and their colleagues at the IMF’s Communications Department, who coordinated the production of this volume.


A robust and well-designed institutional fiscal framework supports responsible, sustainable, and effective fiscal policy. In turn, properly designed fiscal policy contributes to macroeconomic stability, economic growth, while also supporting the needs of the most vulnerable.

Since the early 2000s, Chile’s fiscal policy has been guided by a structural rule and complemented by a sovereign stabilization fund. Successful implementation of this design over time has contributed to the reduction of public debt, favorable financial conditions in international capital markets for Chile, macroeconomic stability, and a more effective countercyclical use of both fiscal and monetary policy. However, the deterioration of a broad set of fiscal metrics in recent years, evidenced by one-notch downgrades by major rating agencies in 2017, suggests there is room for improvement in our fiscal framework.

Recognizing the importance of further strengthening Chile’s fiscal framework, the Ministry of Finance and the International Monetary Fund (IMF) co-organized the conference “Enhancing Chile’s Fiscal Framework: Lessons from Domestic and International Experience” in January of 2019. This booklet summarizes the presentations held during the two-day conference.

As the title of the conference suggests, its objective was to explore challenges and possible opportunities to improve Chile’s fiscal framework, including the fiscal rule, by looking at the Chilean and international experience. We were fortunate in securing the valuable participation of current and former senior policymakers from Chile, including former Ministers of Finance ranging across the political spectrum and Central Bank Governors, which provided an experienced perspective and insights in areas for improvement in the realm of fiscal policy. These views were complemented by representatives from the IMF and the Inter-American Development Bank, academics, and country officials from New Zealand and Peru, which provided lessons from the international experience.

While we continue to discuss these ideas, in line with our firm commitment to fiscal responsibility, we have taken action during our first year in office and significantly outperformed our fiscal targets, narrowing effective and structural deficits, and outpacing the medium-term consolidation path of a reduction of 0.2 percent of GDP per year. Looking ahead, we remain committed to a medium-term structural consolidation path towards a structural deficit of 1 percent of GDP by end-2022, balancing fiscal consolidation efforts and social spending commitments. The public debt-to-GDP ratio is projected to level off soon, well below peers.

We have just strengthened the fiscal institutional framework by providing legal and financial independence to the Autonomous Fiscal Council, while broadening its mandate. We have also enhanced our fiscal transparency with public quarterly macro-fiscal projections, in line with international best practices.

We hope that the ideas discussed in the conference, which are summarized in this booklet, may provide key inputs to further improve Chile’s fiscal framework in the years to come.

Felipe Larraín B.

Minister of Finance of Chile

Summary of the Main Takeaways from the Conference

“Enhancing Chile’s Fiscal Framework: Lessons from Domestic and International Experience”

Metodij Hadzi-Vaskov, Luca Aantonio Ricci, and Klaus Schmidt-Hebbel

The conference focused on identifying challenges and exploring possible opportunities for improvement with respect to Chile’s fiscal rule, drawing both on the domestic experience related to its implementation so far and, more generally, on the international experience with fiscal rules. The presentations and discussions on Day I converged on a set of suggestions that can be valuable for future considerations related to complementing or modifying Chile’s fiscal rule. Many of these suggestions were supported by the findings from the international experience discussed on Day II.

DAY I: Summary of Main Implications for Chile

Key suggestions for Chile

  • Eliminate the spending bias from the output gap cyclical adjustment of about ½ percent GDP per year.
  • Complement the fiscal rule with medium-term/long-term anchors (debt, buffers), and calibrate the cyclically-adjusted balance with such anchors and medium-term/long-term objectives.
  • Undertake countercyclical fiscal policy via escape clauses without changing targets, and follow up with an adjustment mechanism to offset over time past deviations from targets.
  • Enhance transparency and simplicity, by adopting a simpler formula with less complicated parametrization, ensuring it is easier to replicate the cyclical adjustment, and publishing debt trajectories with fan charts.
  • Spell out more explicitly guidelines for choosing targets and tie them to medium-term objectives such as debt and buffers.
  • More generally, embed the fiscal rule within a comprehensive medium-term fiscal strategy.
  • Promote enforcement, preferably via reputation (like requirements to make public statements, presentations in Congress) rather than penalties.
  • The participants expressed clear consensus on the importance of the new autonomous fiscal council, with a strong supervisory and advisory role, political independence and adequate resources.


The Chilean fiscal rule has served the country well, is well regarded by other countries, and has helped fiscal discipline and medium-term planning.

Nonetheless, the conference aimed at providing a recent assessment of the performance of the fiscal rule and learning from the experience of countries with similar issues in terms of business cycle fluctuations and commodity exposure. This is particularly relevant today, in light of the deterioration of public finances over the past few years, visible in a declining fiscal balance, rising debt, and the recent sovereign downgrades by credit rating agencies. There was also a sense among the participants that there is too much discretion in choosing targets and final outcomes, and that the rule does not offer an adequate anchor for medium-term debt or buffers.

In light of Chile’s strong institutions, it was interesting to note a parallelism between monetary and fiscal rules, in terms of a common theoretical inspiration which is to reduce discretion and uncertainty, increase credibility, and guide market expectations.

In considering possible revisions to the rule, one has to bear in mind that such revisions should be infrequent—in order to avoid affecting the credibility of the rule—and has to pay attention to the typical trade-off between the simplicity of the rule and its precision.

Cyclical adjustment

Bias from cyclical adjustment to output. One striking fact that emerged from the discussion is that the cyclical adjustment to the business cycle has always been one-sided (apart from one year). This was due to a persistent overestimation of potential output, which in turns implies an overestimation of structural revenues, and—for a given cyclically-adjusted balance (CAB) target—higher expenditure. Overall, this bias since 2003 has accounted for an annual average contribution to fiscal deficit in the order of ½ percent of GDP, which implies an extra contribution of the primary balance to debt in the order of about 8 percentage points of GDP from 2003 to 2017. The complication in understanding the source of this bias and correcting it comes from the fact that the components of potential growth are provided by the independent expert committee, and the Ministry of Finance assembles such projection inputs into a path for potential GDP level. Hence, either the committee members tend to have a bias on average, or the formula to convert their projections into a potential GDP path is biased and needs to be revised.

Procyclicality of potential GDP and long-term copper price. The forecasts of these parameters have traditionally been procyclical, which is exactly what the fiscal rule is trying to prevent. Unfortunately, this is a common problem. One possible solution is to smoothen the change in the parameters, so as to reduce the procyclicality. Another possible solution is to adopt simpler formula that relies on less parameters (as the ones in the Corbo Commission Report).

Other smaller parameters have been problematic. There is no structural adjustment to the tax revenues for deviations of inflation from the long-run (target). Elasticities have been changed substantially over time and should be explained better. The conversion of long-term reference US dollar copper price into a peso price should rely on a long-term reference exchange rate and not the actual exchange rate which is subject to significant fluctuations.

Defining targets: less flexibility and better anchoring. More explicitly, guidelines should be spelled out for choosing targets. There should be less flexibility in moving CAB targets, as the countercyclical policy can be implemented via escape clauses. CAB targets should be related to medium-or long-term objectives related to debt and assets, and to considerations related to growth and demographics. It would have been useful to publicly explain the persistent reduction in the CAB target levels since the global financial crisis on the basis of such considerations.

Medium-term anchor and calibration of targets

Establishing a clear anchor by directly linking the cyclically-adjusted balance target to long-term objectives. There is a need to calibrate the CAB targets to a stock variable (debt level, accounting for buffers), that should be directly related to long-term fiscal objectives. This procedure would offer the advantage of providing a direct link with sustainability objectives. One would need to ensure an adjustment mechanism in case of deviations from the target, and feedback from flows to stocks. In order to avoid a drift in debt due to repeated shocks, the adjustment would need to be based on cumulative past deviations, so as to allow the debt ratio to return to the level target.

Debt could serve as key anchor. Hence, the CAB target could be calibrated to medium-term debt ratios, considered as a desirable level or target or ceiling. Several challenges arise. The first would be the definition of debt, in particular whether gross or net: net would be economically more meaningful, but gross is more standard, and easier to measure and communicate. The second would relate to the difficulty of choosing a desirable or target level of debt ratio in the medium term. This choice should relate to debt sustainability/solvency and cost of market access considerations, as well as to the need to preserve a borrowing buffer to cope with macroeconomic shocks. The latter for Chile is estimated at about 10–15 percent of GDP, implying that if the choice for a debt ceiling is not to exceed X percent of GDP, the operational debt limit as percent of GDP should be X-10 or X-15. An additional consideration is that the continuation of the past practice of providing below-the-line financing to public companies and public institutions may blur the ability of debt to adequately capture financing and hence erode credibility and impair the effectiveness of the fiscal rule.

More generally, the fiscal rule should be part of a broader comprehensive medium-term fiscal strategy. This involves deciding long-term objectives and spending needs related to growth, demographics, productivity, development, social convergence, vulnerability, and so on. One should analyze the implications of these considerations for the path of stocks of assets and liabilities, which would then guide the calibration of the CAB target and inform the overall budgetary processes. This will provide transparency, clearly spell out the long-term (LT) objectives, and guide public expectations.

Introducing an escape clause and an adjustment mechanism

Countercyclical fiscal policy via escape clauses: it would be preferable to allow for deviations from the target via a formal escape clause, spelling out conditions and triggers. For large shocks, a countercyclical response is essential and can be adopted through invoking escape clauses, while for usual business cycle fluctuations it may be necessary only after automatic stabilizers and monetary policy have played their role (for example, when interest rates hit the zero-lower bound). When undertaken, a countercyclical fiscal response should be exercised via formally defined escape clauses without changing targets, and it should be followed by the implementation of an adjustment mechanism to offset past deviations from targets (so as to limit or eliminate the impact on debt ratios over time). Automatic stabilizers are not large and could be increased. The decision to undertake countercyclical policy should weigh the gains from better economic adjustment against the costs of discretion—which leads to the typical fiscal bias—and of the strong inertia found in expenditure patterns (once expenditure is increased it is difficult to re-adjust it). The clause would need to clearly spell out the variables and the respective level that would trigger a deviation, as well as whether the formal request should be discussed in Congress or assessed by an independent fiscal council. This is not a straightforward exercise in practice and one may want to learn from the positive and negative experiences of many countries.

The clause should be accompanied by a clear adjustment mechanism for deviations from targets. Such mechanism should provide instructions for how to offset the cumulative past deviations from target over the next few years. Such provisions would then become binding for future budgetary processes, with the aim to offset the effect of deviations on stock variables (like debt and assets). Hence this would be compatible with both an implicit or explicit debt target.

Caveats. Good communication would be essential to avoid that invoking an escape clause is perceived as missing the target. Clarity in the rule and strict enforcement of the qualifying conditions would be essential to avoid the risk of beggar-thy-next-government behaviors (spending today forcing the new administration to save): one may also consider the possibility of provisions that all deviations need to be recovered within the mandate of the current administration (as probably done in Germany and Switzerland), but this may not be feasible in emerging markets where volatility and shocks are large.

Accountability, enforcement, simplicity

It is essential to enhance transparency. The calculation of the cyclical adjustments should be made easier to replicate, and the rule could be simplified by adopting a formula with less complicated parametrization. It would be very valuable to publish debt trajectories with fan charts.

Enforcement via reputation rather than penalties. International experience shows that enforcement is difficult to achieve via penalties (hard to enforce), while rule designs that leverage on reputation (like requirements to make public statements, presentations in Congress) tend to work better.

There was a strong consensus on the importance of a new independent fiscal council. Speakers indicated that the implementation would be essential to verify and ensure that the new fiscal council has a significant supervisory and advisory role, enjoys political independence, and has access to adequate resources for its task.

Discussing alternative rules (debt rules already discussed as possible complement to the CAB rule)

Primary deficit is less relevant as a target in countries with stable interest payments as Chile. On the one hand, the use of primary deficit as target is more helpful in countries with very volatile interest rates (payments) and less in countries like Chile. Also, it may negatively affect transparency, given that less people are familiar with that concept. On the other hand, using the primary balance as target would shelter spending from fluctuations in debt, which would affect interest expenditure (note that if the CAB rule would be coupled with a debt target, this point loses relevance).

Norway’s example, saving and investing all revenues from copper. Instead of adjusting for copper revenues through a complicated mechanism, the country could benefit through saving all of them into a Sovereign Wealth Fund (SWF) and spend the return on the fund. However, there are various caveats. First, Norway was already a rich country when it discovered natural resources, with less need for development and social spending, while Chile has higher returns on investing in domestic infrastructure and social spending. These observations imply that parking all revenues in a fund with the aim to invest internationally would be a sub-optimal strategy. Also, with the currently limited copper revenues it would take a long time to build assets whose return can contribute to the budget. An intellectually interesting suggestion was to sell rights to copper extraction and place immediately the equivalent of the net present value of copper revenues in a SWF and then spend the return; the concern was that it is difficult to clearly identify a country with good institutions that can offer successful example of such an initiative. More generally, the non-mining CAB could be considered as a target: the level of the target would implicitly generate an intermediate savings choice in between the Norway example and the regular CAB target case, but it would have the advantage of not having to formally assess the structural revenues of copper.

Expenditure rules may be easier to implement in some cases, though they cannot easily incorporate changes in revenue policies. Such rules are simple relative to CAB rules and may be easier to implement because they are directly linked to the budgetary process. However, expenditure is not the only driver of the fiscal balance: incorporating the effect of tax changes would complicate the rule, defeating the purpose of choosing expenditure rules for their simplicity.

The cyclically-adjusted balance may be a preferable measure to the structural balance. While both concepts are theoretically legitimate, the problems associated with credibility and transparency of the more abstract structural balance favor the use of CAB. Should one need to make one-off adjustments (sale of companies, special tax regime measures Substitute Tax of the Taxable Earnings Fund (ISFUT), or others), the autonomous fiscal council should be involved to provide justification for the inclusion/exclusion of certain components from their calculation.

Fiscal rule’s role in addressing Balance of Payments (BOP) concerns. Besides aiming to address issues related to public debt sustainability, one suggestion was that a broader rule may focus on reducing risks of twin crises by explicitly incorporating BOP aspects, as would have been useful during the Asian crisis when the fiscal deficit was high and the real exchange rate overvalued. However, such concerns are diminished nowadays, as the fiscal rule should prevent large deficits and the exchange rate flexibility should prevent the overvaluation of the exchange rate.

Day II: Summary of Findings from the International Experience

Key conclusions

  • Fiscal rules are increasingly adopted in both emerging/developing economies and industrial countries.
  • Fiscal discipline is needed because every government is subject to an intertemporal budget constraint. Fiscal rules are adopted to strengthen fiscal discipline.
  • Fiscal rules are potentially efficient tools to contribute to fiscal sustainability, solvency, and to macroeconomic performance.
  • There is growing empirical evidence that fiscal rules tend to improve fiscal performance.
  • Fiscal rules should be designed with a holistic view of the fiscal framework.
  • Rules come in all types and shapes, but several rules are improperly designed.
  • Complexity and technicality on fiscal rules result in manipulation and less credibility of rules.
  • Many countries in Latin America and the Caribbean (LAC) have introduced fiscal rules. However, significant design and compliance problems have hampered their effectiveness in several LAC countries.
  • Fiscal rules should preferably target the evolution of public debt-to-GDP ratio—as in New Zealand—because stability of the long-term debt path is at the core of fiscal sustainability.
  • A well-designed fiscal rule should be flexible, simple, transparent, rest on a single target, and should be complied with.

The rationale for fiscal rules

Fiscal discipline is a policy cornerstone because every government is subject to a budget constraint. Fiscal discipline is essential to improve and sustain fiscal solvency, good economic performance, and macroeconomic stability. Fiscal discipline is needed to avoid high, unsustainable levels of public debt that damage economic growth and welfare.

Constraining budgetary decisions is needed in response to market failures and political-economy constraints. Governments are subject to intense demands for more spending and political constraints that inhibit the increase of taxes. Public debt through financial markets is another source of financing public spending. However, financial markets can quickly switch from trust to mistrust and abruptly cut lending to governments, leading to highly disruptive crises.

The government budget constraint is about the path of public debt. In order to contain pressures to overspend, so as to ensure fiscal responsibility and debt sustainability, the constraint must be about the evolution of debt. A high level of debt that is set to decline is consistent with discipline, while a low debt level that grows continuously is not. Fiscal solvency and debt sustainability are a central tenet of government policy.

Fiscal rules are adopted to strengthen fiscal discipline and macroeconomic stability. A fiscal rule imposes a long-term constraint on fiscal policy through numerical limits on budgetary aggregates. Fiscal rules typically aim at correcting distorted incentives and containing pressures to overspend, particularly in good times, so as to ensure fiscal discipline. Thus, fiscal rules are instrumental in strengthening the fiscal stance of an economy.

Design principles of fiscal rules

Fiscal rules should be designed with a holistic view of the fiscal framework. Fiscal rules are one component of the comprehensive fiscal framework. Hence their design cannot be improved in isolation from the quality of the overall framework. A well-designed fiscal framework should have a clear long-term objective, an explicit fiscal anchor that guides fiscal policy over the medium term, and a fiscal rule that guides fiscal policy over the short term.

Fiscal rules should support the capacity of fiscal policy to fulfill its three ultimate objectives: smoothing the economic cycle, fostering long-term growth, and promoting inclusiveness.

A well-designed fiscal rule should be flexible, simple, transparent, rest on a single target, and should be complied with. Macroeconomic stability is supported by having sufficient flexibility to accommodate shocks and should not lead to complexity. Escape clauses strike this balance by pre-establishing conditions, modality, and duration of deviations from the rule in case exceptional circumstances materialize.

A multi-target rule does not improve the logic of each target. It is nearly impossible to bring coherence to the various targets, so that in any given year some may be satisfied but others not. The rule should be easily understood by decision makers and the public. Adding too many constraints can impair the ability of the government to achieve its policy objectives, undermining the credibility of the framework. Complexity and technicality result in opacity, and opacity opens the door to manipulation.

Fiscal rules should be complied with. This is more likely to happen if compliance mechanisms are based on incentives, that is by raising the costs of noncompliance and creating more tangible benefits for compliance. Compliance with the rule should be easy to verify, and there should be costs associated with deviations from targets.

Fiscal rules should target the evolution of debt relative to GDP. Theory says that the proper target is the evolution of the debt to GDP ratio in the long term. The long-term debt depends on the whole path of budget balances and on assumptions about interest and growth rates. Stability of the long-term debt path is consistent with the concept of fiscal discipline. This approach does not tie down a government to an arbitrary predetermined numerical target. It rather requires from the government to make the case that its budgetary decisions are disciplined. Fiscal rules will not make much of a difference if the budget horizon is limited to a single year, monitoring and enforcement are weak, and future impacts are ignored when budget decisions are made.

Types of rules in practice

Fiscal rules are increasingly adopted in both emerging/developing economies and industrial countries. Since the 1990s adoption of fiscal rules is spreading around the world, as part of significant reforms of fiscal frameworks, undertaken by many industrial countries and emerging/developing economies. As of 2015, 92 countries have at least one type of fiscal rule in place. Fiscal rules are quantitative targets on levels, GDP-ratios or growth rates of government budget balance, debt, expenditure, and/or revenue.

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. 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). In 2015, 76 countries have adopted DR, 78 have BBR, 14 have revenue rule (RR), and 45 have ER.

Several rules are improperly designed. Annual targets for the budget balance, focusing on the short run, present two shortcomings. They have limited impact on the long-term evolution of the debt, and they ignore that a key function of fiscal policy is to counteract shocks that lead to expansions and recessions. A BBR defined as an annual budget balance target ratio to current GDP, which is invariant to cyclical conditions, induces pro-cyclicality of government expenditure. A BBR defined as a cyclically-adjusted 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.

Structural balance rules are an extension of cyclically-adjusted rules. They adjust the overall balance beyond the business cycle by correcting revenue and spending for one-off fiscal measures. Targeting the structural balance allows for automatic stabilizers to operate, but it suffers from the difficulty to compute the structural balance with precision. Monitoring and computation are even more complicated than under cyclically-adjusted balance rules. For example, the designation of one-offs is challenging in practice. It hinges on perceptions about the likely temporary nature of the measures, and policymakers might be tempted to choose them strategically.

Expenditure rules set limits on total, primary, or current spending, and the limits apply to nominal or real expenditure. Targeting expenditure (at annual levels or growth rate) improves government control but is not directly related to fiscal discipline. The adequacy of an expenditure target rests on the evolution of government revenue. To ensure debt sustainability, expenditure rules require specific design features. Basic expenditure rules that do not take the revenue side into account have only a partial impact on debt dynamics.

Adopting and developing fiscal rules

Fiscal rules are adopted to strengthen one or several key policy objectives. Macroeconomic stability is enhanced by counter-cyclical government expenditure, which could be achieved by a BBR, a DR or an 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.

A wide set of political, structural, economic, and fiscal conditions contribute significantly to the likelihood of having a fiscal rule in place. The role of several variables has been addressed empirically by the literature on fiscal rules. The literature has found that institutional and political conditions contribute significantly to the likelihood of having a fiscal rule in place. While fixed exchange rate regimes do not contribute to explain why countries have rules, inflation targeting regimes do. Capital account openness and financial development contribute to having fiscal rules. Volatility of government revenue inhibits having a rule. Finally, measures of fiscal conditions contribute significantly to having a national fiscal rule in place.

Fiscal councils contribute to fiscal rule effectiveness. Every step in the process of fiscal decisions is subject to potential fiscal bias. For example, government forecasts of macroeconomic variables and government balance and debt levels is often biased in direction of a stronger fiscal balance than what an unbiased assessment would provide. Independent and competent fiscal councils reduce the likelihood of this bias and of inappropriate use of fiscal rules, enhancing their effectiveness.

Effects of fiscal rules

There is evidence that fiscal rules improve fiscal performance. Recent empirical research tests for the contribution of fiscal rules to fiscal-policy performance in a large world sample. One of the studies presented in this conference estimates the effects of three types of rules—ER, BBR, and DR, 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. Neither a BBR nor a DR have a statistically significant effect on the pro-cyclicality of government expenditure. But 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.

There is also evidence that fiscal rules contribute to overall macroeconomic performance. A review of the empirical literature 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.

Fiscal rules in Latin America and the Caribbean

Many countries in LAC have adopted fiscal rules. The adoption of fiscal rules began with only two countries in 2000. To date, 14 countries in the region have adopted fiscal rules. Among them, Peru adopted a BBR and a DR in 2000, Mexico adopted a BBR in 2006, and Colombia introduced a structural balance rule in 2014.

Fiscal rules should be flexible. While several LAC countries have undertaken fiscal consolidation programs, most of the adjustment falls on capital expenditure. The question is therefore whether fiscal rules can protect investment expenditure in times of fiscal adjustment. More flexible rules that include clearly defined escape clauses, cyclically-adjusted balances, or investment-friendly rules can protect capital expenditure during periods of fiscal adjustment.

The presence of any fiscal rule is not enough to achieve fiscal discipline. LAC’s experience shows that the design of fiscal rules is a key factor in their effectiveness. In order to be effective, fiscal rules require: (i) broad institutional coverage; (ii) a sound legal base; (iii) compliance mechanisms; and (iv) flexibility in addressing shocks.

There are multiple design problems with several fiscal rules in LAC. These include a lack of clarity of the fiscal rule (including estimation of structural parameters), excessive use of escape clauses, lack of flexibility, and weaknesses in compliance. From 2006 to 2014, the fiscal rule of Mexico was ineffective due to its complexity and the governments’ excessive use of escape clauses and weak fiscal management. In particular, governments faced problems in estimating structural income, which have led to continuous revisions of balance targets, undermining the credibility of the rule.

However, there have been improvements in the treatment of fiscal rules. Governments in LAC are addressing some of the above-mentioned weaknesses by applying broader measures of the government balance as a fiscal target, implementing independent fiscal councils, and defining more transparent fiscal rules. Although these changes represented significant progress, several challenges have yet to be addressed, including more precise definitions of conditions under which escape clauses can be invoked. Mexico has improved its fiscal rule by applying it to the broadest measurement of the balance as a fiscal target and by adopting a structural expenditure rule. Peru has improved its fiscal rule through several policies aimed at higher fiscal prudence. In particular, Peru has started a Maslow-type approach regarding fiscal prudence levels and has adopted an independent fiscal council.

Fiscal frameworks must take care of the potential fiscal impact of tail risks. Materialization of tail risks—low-probability but very adverse shocks—causes crises and deep recessions unless preventive fiscal policies prepare for such scenarios. Peru has prepared to deal with tail risks by broadening its toolbox of financial instruments to better hedge against such risks.

Fiscal rules have the potential to be valuable tools in achieving sustainable fiscal policies in LAC. However, design and compliance mechanisms are as important as the choice of fiscal rule. Rules that are based on a broad public-sector coverage, sound compliance incentives, effective oversight institutions (foremost a fiscal council), and flexibility in addressing shocks are more likely to be effective.

New Zealand’s fiscal framework

New Zealand’s fiscal framework has endured over nearly three decades. The main features of the fiscal framework are its emphasis on principles of fiscal responsibility, transparency, and independence in reporting, standards, and auditing. New Zealand’s fiscal framework has been effective in supporting fiscal sustainability.

New Zealand has used a debt rule to guide fiscal policy. The form of the debt anchor has changed over time, reflecting changes in policy and economic circumstances. This includes changes to the definition (net debt, gross debt), form (range, ceiling, point targets), and target levels for the debt anchor. Determining a prudent level of debt requires an on-balance judgement, considering the buffer needed to manage shocks, wider macroeconomic vulnerabilities, structural changes that will influence long-term fiscal sustainability, intergenerational equity, public investment and debt dynamics.

The fiscal rule is supplemented by other short-term targets that provide operational guidance. A wide range of indicators is used to develop the fiscal strategy, including a full balance sheet. Reporting in budget documents is also broadening to include a wider range of wellbeing indicators.

The fiscal rule adopted by New Zealand is relatively simple, flexible, and targeted at medium-term outcomes. There is wide public and cross-party commitment to keeping public debt at prudent levels. Targeting medium-term outcomes also avoids the need for setting fiscal targets in cyclically-adjusted terms, as the output gap is expected to be closed in the medium term. Cyclically-adjusted targets are more complex, and subject to estimation uncertainty, making them harder to communicate. A medium-term budgeting framework is important for ensuring the fiscal anchor provides operational guidance to the annual budget process.

The fiscal framework has been resilient to political and economic changes. The moderate changes and improvements to New Zealand´s fiscal framework have reflected successive governments´ priorities, setting their own fiscal strategies while reinforcing strong political commitment. Rather than relying on enforcement of legislated numerical fiscal rules, New Zealand’s framework provides effective incentives for governments to conduct responsible fiscal policy.

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