Prepared by Carlos Caceres (FAD) and Marta Ruiz-Arranz (EUR). Based on data as of June 2010.
The golden rule stated that the government should only borrow to fund investment. The sustainable investment rule stated that public sector net debt should not be higher than 40 percent of GDP. Both rules were designed to be met over the course of an economic cycle (HM Treasury, 2008).
Announced plans have been drawn up to meet this objective one year early, thus providing some margin.
The required speed of adjustment may be excessive. Furthermore, the current uncertain economic environment may complicate the establishment of an appropriate target and the implementation of policies to attain it. The relevance of these considerations would depend on the specifics of the new rules.
In mid-2009, the government announced a fiscal rule, which would require the federal government to maintain a structural deficit not exceeding 0.35 percent of GDP. This rule will take effect in 2016 with a transition period from 2011.
From the simulation exercise point of view, there is no difference between a structural balance rule and the Swiss debt brake described in Box 1. Both rules aim at maintaining a structural balance target, allowing for cyclical factors. Both rules can embed an automatic correction mechanism (debt brake) for deviations due to discretionary policy or forecast errors, as is the case in the Swiss rule and in the new German rule. Since the simulations assume no deviations from the rule, this correction mechanism is not triggered.
Note that in analyzing the response of the rules, these simulations take the actual output path as exogenously given.
The average ex-post gap in 2002-2007 was -0.1 percent, compared to an ex-ante estimate of -0.4 percent.
Note that these simulations do not include the effect that different fiscal balance levels could have on output.
The larger increase in the deficit under the AGB rule relative to the structural balance rule is mainly because, for a given revenue-to-GDP ratio, a structural balance rule effectively allows real spending to grow at the rate of estimated potential real GDP growth, which fell during the recession down to an average of about 1 percent over 2008-09. In contrast, the AGB rule effectively allows real spending to grow at the trend growth rate (2.3 percent), which is fixed in the rule and does not change during the recession.
Relative to a structural balance rule with the same average degree of cyclicality (as calibrated by the coefficients), the AGB rule will tend to produce more “front-loaded” fiscal policy: the fiscal stance will be more expansionary in the early stages of recessions and more contractionary in the early stages of recovery. However, Fletcher and Benelli (2010) show that the differences with a structural balance rule are typically modest—in general, the AGB rule broadly mimics the cyclical path of a structural balance rule.
For presentational purposes, only the overall balance and debt-ratio simulations are shown here.
The relevance of this consideration would depend in part on the specifics of the rule chosen. For example, the AGB rule allows for gradual adjustment from any starting point, which reduces or eliminates the need for a transition period.
If discretion in estimating the output gap is viewed as problematic, fiscal rule legislation could even specify the method by which the output gap should be calculated for purposes of determining the deficit ceiling prescribed by the structural balance rule.