Why Don't We Follow the Rules? Drivers of Compliance with Fiscal Policy Rules in Emerging Markets

Abstract

Under what conditions do countries comply with their fiscal policy rules? We tackle this question in the context of emerging countries, with a specific focus on Latin America and the Caribbean, a region where fiscal rules have become increasingly common in recent decades. Based on an original dataset of compliance behavior across 14 countries observed between 2000 and 2020, we first document that complying with fiscal rules makes a difference: countries that comply with their fiscal rules show, on average, lower sovereign bond spreads, higher credit ratings, and lower probability of public debt acceleration episodes than countries that do not comply with their rules. We then show that compliance is affected by the broader macroeconomic and politico-institutional environment. First, we find an asymmetrical response of compliance to macroeco-nomic conditions: while compliance decreases during bad times, it does not improve during good times. Second, optimistic macroeconomic forecasts undermine compliance during the budget preparation phase: the probability of complying ex-post with the fiscal rule is lower when policymakers overestimate GDP growth ex-ante. Finally, a solid institutional environment supporting commitment to fiscal discipline is a strong predictor of fiscal rule compliance across emerging countries. Our findings contribute to the literature on fiscal rule effectiveness by showing the relevant pre-conditions that may foster or inhibit the successful implementation of rules-based fiscal frameworks.