Do fiscal rules pave the way for sound fiscal policy?

Abstract

In many countries, the past few decades have been characterized by large budget deficits and excessive public debt levels, also outside of the financial crisis and the COVID-19 outbreak. However, sound fiscal policy is important for a healthy and stable economy. Fiscal discipline is therefore needed so that governments have room to stimulate the economy when it is struggling without jeopardizing the sustainability of public finances.In this thesis, I examine if fiscal rules can be of help. These rules impose constraints on fiscal policy, such as a limit for the budget deficit or a ceiling for public debt. The results show that fiscal rules are indeed desirable tools to reduce fiscal imbalances. Countries that adopt well-designed fiscal rules have lower budget deficits and are less likely to implement policies that destabilize the economy. Moreover, fiscal rules trigger important adjustments that stimulate governments to consolidate unsustainable fiscal policies. Therefore, strengthening fiscal rules helps countries in paving the way for sound fiscal policies. Strengthening fiscal rules is nonetheless unlikely to be sufficient to ensure fiscal soundness. The results show that government decision-making is strongly influenced by the consequences of inadequate policies. Besides fiscal rules, other factors also play an important role. The impact of fiscal rules therefore also depends on other factors. Most notably, transparency in fiscal policy appears to be important for the effect of fiscal rules. This thesis shows that by facilitating the supervision of fiscal policies, fiscal rules are more likely to lead to the desired outcomes.