Fiscal Rules: Challenges and Reform Opportunities for Emerging Markets

Abstract

Fiscal rules have gained popularity as tools to strengthen debt sustainability by constraining policy discretion. However, their track record in the case of emerging markets is mixed, as setting up a fiscal rule has been no guarantee of debt stabilization. International experience and empirical evidence regarding the working of fiscal rules suggest that paying attention to the quality of rule design, the mechanisms behind better compliance, forward guidance on return to the rule, and the impacts on different dimensions of public finances (particularly spending composition) is key to enhancing fiscal rule performance. In addition, fiscal rules should be complemented with credible medium-term fiscal frameworks and independent fiscal councils that together set relevant policy anchors to support effectively the goal of safeguarding fiscal sustainability.

Searching for a Safe Harbor: Fiscal Policy Responses in Small Island Developing States

“…The responsiveness of primary balances to fiscal rules are also more apparent under the assumption of heterogenous responses to output gaps. Ardanaz et al (2023) also find evidence of heterogenous responses to fiscal rules-Latin America and the Caribbean countries are less compliant during downturns and compliance does not improve during business cycle upturns. Furthermore, these results also raise the question of how business cycles should be modeled-the assumptions underlying their inclusion can influence whether some explanatory variables are statistically significant or not.…”

“…On the other hand, Everaert and Jansen (2017) did find a positive and statistically significant impact on the primary balance using a sample of OECD countries. One key issue is effective compliance with quantitative fiscal rules, as document in Ardanaz et al (2023).…”

“…Most countries in the sample do not have in place transparent fiscal rules that are both monitored and enforced. The lack of a strong institutional environment may decrease compliance with fiscal rules and thus may increase the likelihood of fiscal deficits that can arise during economic upswings (Ardanaz, Ulloa-Suarez, and Valencia 2023). The responsiveness of primary balances to fiscal rules are also more apparent under the assumption of heterogenous responses to output gaps.…”

2024 Latin American and Caribbean Macroeconomic Report: Ready for Take-Off? Building on Macroeconomic Stability for Growth

“…Similarly, simply imposing a fiscal rule is insufficient to ensure sustainability, measured in terms of public debt growth, changes in debt-to-GDP ratios, or debt volatility. Ardanaz, Cavallo, and Izquierdo (2023) show, paradoxically, that public debt growth and changes in debt-to-GDP ratios are worse for countries that have a fiscal rule than for those that do not (see Figure 3.9, Panel A). 3…”