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This paper assesses the impact of different types of flexible fiscal rules on the procyclicality of fiscal policy with propensity scores-matching techniques, thus mitigating traditional self-selection problems. It finds that not all fiscal rules have the same impact: the design matters. Specifically, investment-friendly rules reduce the procyclicality of both overall and investment spending. The effect appears stronger in bad times and when the rule is enacted at the national level. The introduction of escape clauses in fiscal rules does not seem to affect the cyclical stance of public spending. The inclusion of cyclical adjustment features in spending rules yields broadly similar results. The results are mixed for cyclically-adjusted budget balance rules: enacting the latter is associated with countercyclical movements in overall spending, but with procyclical changes in investment spending. Structural factors, such as past debt, the level of development, the volatility of terms of trade, natural resources endowment, government stability, and the legal enforcement and monitoring arrangements backing the rule also influence the link between fiscal rules and countercyclicality. The results are robust to a wide set of alternative specifications.
Fiscal rule frameworks have evolved significantly in response to the global financial crisis. Many countries have reformed their fiscal rules or introduced new ones with a view to enhancing the credibility of fiscal policy and providing a medium-term anchor. Enforcement and monitoring mechanisms have also been upgraded. However, these innovations have made the systems of rules more complicated to operate, while compliance has not improved. The SDN takes stock of past experiences, reviews recent reforms, and presents new research on the effectiveness of rules. It also proposes guiding principles for future reforms to strike a better balance between simplicity, flexibility, and enforceability. Read the blog
This paper estimates the causal effect of fiscal rules on fiscal balances in a panel of 142 countries over the period 1985-2015. Our instrumental variable strategy exploits the geographical diffusion of fiscal rules across countries. The intuition is that reforms in neighboring countries may affect the adoption of domestic reforms through peer pressure and imitational effects. We find that fiscal rules correlate with lower deficits, but the positive link disappears when endogeneity is correctly addressed. However, when considering an index of fiscal rules’ design, we show that well-designed rules have a statistically significant impact on fiscal balances. We conduct several robustness tests and show that our results are not affected by weak instrument problems.
This paper explores how fiscal policy can affect medium- to long-term growth. It identifies the main channels through which fiscal policy can influence growth and distills practical lessons for policymakers. The particular mix of policy measures, however, will depend on country-specific conditions, capacities, and preferences. The paper draws on the Fund’s extensive technical assistance on fiscal reforms as well as several analytical studies, including a novel approach for country studies, a statistical analysis of growth accelerations following fiscal reforms, and simulations of an endogenous growth model.
Recently, monetary authorities have increasingly focused on implementing policies to ensure price stability and strengthen central bank independence. Simultaneously, in the fiscal area, market development has allowed public debt managers to focus more on cost minimization. This “divorce” of monetary and debt management functions in no way lessens the need for effective coordination of monetary and fiscal policy if overall economic performance is to be optimized and maintained in the long term. This paper analyzes these issues based on a review of the relevant literature and of country experiences from an institutional and operational perspective.
Many countries, especially developing ones, follow procyclical fiscal polices, namely spending goes up (taxes go down) in booms and spending goes down (taxes go up) in recessions. We provide an explanation for this suboptimal fiscal policy based upon political distortions and incentives for less-than-benevolent government to appropriate rents. Voters have incentives similar to the "starving the Leviathan" classic argument, and demand more public goods or fewer taxes to prevent governments from appropriating rents when the economy is doing well. We test this argument against more traditional explanations based purely on borrowing constraints, with a reasonable amount of success.
The pamphlet (which updates the 1995 Guidelines for Fiscal Adjustment) presents the IMF’s approach to fiscal adjustment, and focuses on the role that sound government finances play in promoting macroeconomic stability and growth. Structured around five practical questions—when to adjust, how to assess the fiscal position, what makes for successful adjustment, how to carry out adjustment, and which institutions can help—it covers topics such as tax policies, debt sustainability, fiscal responsibility laws, and transparency.
This paper reviews the theoretical and empirical literature on the effectiveness of fiscal policy. The focus is on the size of fiscal multipliers, and on the possibility that multipliers can turn negative (i.e., that fiscal contractions can be expansionary). The paper concludes that fiscal multipliers are overwhelmingly positive but small. However, there is some evidence of negative fiscal multipliers.
Fiscal policy in Latin America has been guided primarily by short-term liquidity targets whose observance was taken as the main exponent of fiscal prudence, with attention focused almost exclusively on the levels of public debt and the cash deficit. Very little attention was paid to the effects of fiscal policy on growth and on macroeconomic volatility over the cycle. Important issues such as the composition of public expenditures (and its effects on growth), the ability of fiscal policy to stabilize cyclical fluctuations, and the currency composition of public debt were largely neglected. As a result, fiscal policy has often amplified cyclical volatility and dampened growth. 'Fiscal Policy, Stabilization, and Growth' explores the conduct of fiscal policy in Latin America and its consequences for macroeconomic stability and long-term growth. In particular, the book highlights the procyclical and anti-investment biases embedded in the region's fiscal policies, explores their causes and macroeconomic consequences, and asesses their possible solutions.
Strengthening fiscal frameworks, in particular fiscal rules, has emerged as a key response to the fiscal legacy of the crisis. This paper takes stock of fiscal rules in use around the world, compiles a dataset - covering national and supranational fiscal rules, in 81 countries from 1985 to end-March 2012 - and presents details about the rules’ key design elements, particularly in support of enforcement. This information is summarized in a set of fiscal rules indices. Three key findings emerge: (i) many new fiscal rules have been adopted and existing ones strengthened in response to the crisis; (ii) the number of fiscal rules and the comprehensiveness of the design features in emerging economies has caught up to those in advanced economies; and (iii) the "next-generation" fiscal rules are increasingly complex as they combine the objectives of sustainability and with the need for flexibility in response to shocks, thereby creating new challenges for implementation, communication, and monitoring.