Budget Balance Rules Research Articles

Stabilizing, neutral or destabilizing? The impact of fiscal rules on the GDP volatility in the EU countries

The goal of the present article is to estimate the impact of numerical fiscal rules on the volatility of GDP growth in the European Union countries in 1995–2019 to answer the question about their counter--cyclical and stabilizing properties. The obtained results show that the introduction and the wider use of fiscal rules in the EU countries reduced economic fluctuations – an increase in the Fiscal Rules Index of one standard deviation was associated with a decrease in the volatility of the GDP growth rate of approximately 20%. When analysing different types of fiscal rules existing in the EU countries, the biggest reduction in GDP volatility was obtained for countries where debt rules were in force. In the case of “operational” rules, the budget balance rules have a stronger impact on limiting GDP growth fluctuations, while the impact of expenditure rules in this matter turned out to be insignificant.

Authorities’ Fiscal Forecasts in Latin America: Are they Optimistic?

Do governments in Latin America tend to be optimistic when preparing budgetary projections? We address this question by constructing a novel dataset of the authorities’ fiscal forecasts in six Latin American economies, using data from annual budget documents over the period 2000–2018. We compare such forecasts with the outturns reported in the corresponding budget documents of the following years, to understand the evolution of fiscal forecast errors. Our findings suggest that: (i) there is no general optimistic bias in the forecasts for the fiscal balance-to-GDP ratio; (ii) over time, fiscal forecasts have improved for some countries and worsened for others; (iii) forecast errors for the fiscal balance-to-GDP ratio are positively correlated with GDP growth and terms-of-trade changes, and negatively correlated with GDP deflator surprises; (iv) forecast errors for public debt-to-GDP ratios are negatively associated with surprises to GDP growth; and (v), budget balance rules may help contain fiscal forecast errors. JEL Classification Codes: E6, H50

재정준칙과 정부 부패

A fiscal rule is a long-lasting constraint on fiscal policy through numerical limits on budgetary aggregates. Several empirical studies have shown that countries with fiscal rules tend to have better fiscal outcomes. This paper estimates the causal effect of fiscal rules on government corruption in a panel of 36 OECD countries over the period 1994-2015. This paper finds that Expenditure Rules, Debt Rules correlate with lower government corruption. However, Budget Balance Rules with higher government corruption. This paper contributes to the empirical literature on the effectiveness of fiscal rules by developing a new instrumental variables strategy. Above all, an independent financial institutions have a positive effect on the adoption of fiscal rules. This study suggest that independent financial institutions can enhance the adoption of fiscal rules and government transparency.

Authorities' Fiscal Forecasts in Latin America: Are They Optimistic?

Do governments in Latin America tend to be optimistic when preparing budgetary projections? We address this question by constructing a novel dataset of the authorities' fiscal forecasts in six Latin American economies using data from annual budget documents over the period 2000-2018. In turn, we compare such forecasts with the outturns reported in the corresponding budget documents of the following years to understand the evolution of fiscal forecast errors. Our findings suggest that: (i) for most countries, there is no general optimistic bias in the forecasts for the fiscal balance-to-GDP ratio (though there may be for the components); (ii) fiscal forecasts have improved for some countries over time, albeit they have worsened for others; (iii) in terms of drivers, we show that forecast errors for the fiscal balance-to-GDP ratio are positively correlated with GDP growth and terms of trade changes and negatively with GDP deflator surprises; (iv) forecast errors for public debt-to-GDP ratios are negatively associated with surprises to GDP growth; (v) lastly, budget balance rules seem to help contain the size of the fiscal forecast errors.

Twin deficits revisited: A role for fiscal institutions?

We revisit the twin-deficits relationship for a sample of 65 countries with fiscal rules over the period 1985–2015, using a panel data estimation methods. Our analysis accounts for the role of various types of fiscal rules and institutions: expenditure rules, revenue rules, budget balance rules, debt rules, fiscal councils, and supporting procedures. We find that the twin-deficits hypothesis is confirmed. The impact of the budget balance on the current account balance is increased when fiscal rules are considered, except with revenue rules and debt rules. Well-designed fiscal rules, fiscal councils and features that reinforce compliance with rules improve the current account balance. Our findings highlight the role of fiscal factors in explaining sustained global current account imbalances. They also contribute to the ongoing discussion about the improvement of macroeconomic and budgetary surveillance in the European context.

Authorities’ Fiscal Forecasts in Latin America: Are They Optimistic?

Do governments in Latin America tend to be optimistic when preparing budgetary projections? We address this question by constructing a novel dataset of the authorities' fiscal forecasts in six Latin American economies using data from annual budget documents over the period 2000-2018. In turn, we compare such forecasts with the outturns reported in the corresponding budget documents of the following years to understand the evolution of fiscal forecast errors. Our findings suggest that: (i) for most countries, there is no general optimistic bias in the forecasts for the fiscal balance-to-GDP ratio (though there may be for the components); (ii) fiscal forecasts have improved for some countries over time, albeit they have worsened for others; (iii) in terms of drivers, we show that forecast errors for the fiscal balance-to-GDP ratio are positively correlated with GDP growth and terms of trade changes and negatively with GDP deflator surprises; (iv) forecast errors for public debt-to-GDP ratios are negatively associated with surprises to GDP growth; (v) lastly, budget balance rules seem to help contain the size of the fiscal forecast errors.

Fiscal policy performance and economic downturn – the experience of the European Union countries outside the euro area

Background: In recent years, imbalances in public finances have been building up in many countries of the European Union, and it has been influenced by, among others, the expansionary fiscal policies implemented during the economic downturns. The beginning of the 21st century was affected by two severe recessions caused by shocks of different natures. Therefore, there is an interest in comparing how fiscal policy was conducted before and during both recessions.
 Research purpose: The paper aims to identify changes in fiscal policy and the main causes of these changes in six Central and Eastern European countries outside the euro area, i.e., Bulgaria, Czechia, Croatia, Hungary, Poland, and Romania. The focus is on comparing the paths and developments of fiscal policy aggregates before and during the two recessions that occurred in the first decades of the 21st century.1
 Methods: The evaluation of fiscal policy is based on a large (full) sample, which covers 2004 to 2019, and sub-samples, which allows for an evaluation of fiscal policy before the two downturns, i.e., before the economic crisis from the first decade of the 21st century, and before the “COVID-19” crisis. The main attention is paid to analyzing the changes in debt development, changes in the budget balance against the background of the cyclical indicator – fiscal stance, and evaluating domestic fiscal rules in the context of fiscal governance, and recognizing the scale of fiscal imbalances. The data used are mainly based on the AMECO database.
 Conclusions: The comparison of the fiscal policy performance in the period one year before both crises shows that almost all countries under consideration in 2008 conducted a procyclical policy, whereas in 2019, the fiscal policy was procyclical in all six countries. Regardless of the fact that in recent years the countries increased the number of national fiscal rules, especially domestic budget balance rules, the fiscal policy stance was somewhat procyclical. Moreover, the analyzed countries have large disparities in the level of debt-to-GDP ratio.

Individual Treatment Effects of Budget Balance Rules

This paper investigates the heterogenous effects of budget balance rules on fiscal policy in a large sample of countries. To derive country-specific treatment effects of fiscal rules and conduct inference, we use a Synthetic Difference-in-Differences Method. Our results indicate that countries with a budget balance rule improve their fiscal balance on average by around 3 percent after its introduction. However, our results also illustrate the importance of going beyond the average treatment effect, as it masks significant heterogeneity in the country-specific impact of the rule. We find that countries that would have had large deficits in the absence of the fiscal rule exhibit positive treatment effects, thus reducing their budget deficits. On the other hand, countries with budget surpluses respond to fiscal rules by reducing their budget surplus and moving closer to the numerical target of the rule. Our results also suggest that rules’ design matters: a small overall number of fiscal rules, and the presence of a monitoring process outside the government, especially at the supra-national level, improve significantly the effectiveness of the rules.

The cost of banking crises: Does the policy framework matter?

This paper empirically investigates how the stringency of monetary, fiscal and exchange rate policy frameworks impacts the expected cost of banking crises. A restrictive policy framework may promote stronger banking stability, by enhancing discipline and credibility, and by giving financial room to policymakers. At the same time though, tying the hands of policymakers may be counterproductive and procyclical, especially if it prevents them from responding properly to financial imbalances and crises. Our analysis considers a sample of 146 countries over the period 1970–2013, and reveals that extremely restrictive or lax policy frameworks are likely to increase the expected cost of banking crises. By contrast, by combining discipline and flexibility, some policy arrangements such as budget balance rules with an easing clause, intermediate exchange rate regimes or an inflation targeting framework may significantly contain the expected cost of banking crises. As such, we provide evidence on the benefits of “constrained discretion” for the real impact of banking crises.

Individual Treatment Effects of Budget Balance Rules

This paper investigates the heterogenous effects of budget balance rules on fiscal policy in a large sample of countries. To derive country-specific treatment effects of fiscal rules and conduct inference, we use a Synthetic Difference-in-Differences Method. Our results indicate that countries with a budget balance rule improve their fiscal balance on average by around 3 percent after its introduction. However, our results also illustrate the importance of going beyond the average treatment effect, as it masks significant heterogeneity in the country-specific impact of the rule. We find that countries that would have had large deficits in the absence of the fiscal rule exhibit positive treatment effects, thus reducing their budget deficits. On the other hand, countries with budget surpluses respond to fiscal rules by reducing their budget surplus and moving closer to the numerical target of the rule. Our results also suggest that rules' design matters: a small overall number of fiscal rules, and the presence of a monitoring process outside the government, especially at the supra-national level, improve significantly the effectiveness of the rules.

The Cost of Banking Crises: Does the Policy Framework Matter?

This paper empirically investigates how the stringency of macroeconomic policy frameworks impacts the unconditional cost of banking crises. We consider monetary, fiscal and exchange rate policies. A restrictive policy framework may promote stronger banking stability, by enhancing discipline and credibility, and by giving financial room to policymakers. At the same time though, tying the hands of policymakers may be counterproductive and procyclical, especially if it prevents them from responding properly to financial imbalances and crises. Our analysis considers a sample of 146 countries over the period 1970-2013, and reveals that extremely restrictive policy frameworks are likely to increase the expected cost of banking crises. By contrast, combining discipline and flexibility means that some policy arrangements such as budget balance rules with an easing clause, intermediate exchange rate regimes or an inflation targeting framework may significantly contain the cost of banking crises. As such, we provide evidence on the benefits of constrained discretion for the real impact of banking crises.

Fiscal rules and procyclicality: an empirical analysis

While it is well acknowledged and researched that fiscal rules promote fiscal discipline, there is still apprehension that fiscal rules by imposing strict constraints on fiscal spending can be procyclical and destabilising. It could happen that when the need of the hour is to increase expenditures during bad times and control expenditures in good times, fiscal rules may tempt governments to trail the opposite path. Using a panel GMM model, this paper has tried to empirically test whether the nature of fiscal rule influences this procyclicality of fiscal policy in a cross-country panel framework for 61 countries for the post 2000 period. Considering that countries have shifted overtime towards fiscal rules adjusted for cycles to reduce the procyclicality bias, the above is tested under two alternate variants of fiscal rules, i.e., those with conventional budget balance rules and those who have fiscal rules adjusted for business cycle impact usually called cyclically adjusted balances (CAB)/structural balance (SB) rules. Empirical results support that while adoption of simple budget balance fiscal rules has not been able to protect these economies from procyclical fiscal policy, the adoption of CAB/SB based fiscal rules are associated with countercyclical fiscal policy. Results of the paper, thus, support the policy conclusion that designing fiscal rules that incorporate business cycles into the target, either via well-defined escape clauses or through formulation of limits in cyclically adjusted terms, can achieve the dual objective of fostering higher growth while simultaneously maintaining fiscal discipline.

Twin Deficits Revisited: A Role for Fiscal Institutions?

We revisit the twin deficit relationship for a sample of 193 countries over the period 1980-2016, using a panel fixed effect (within-group) estimator, bias-corrected least-squares dummy variable, system GMM, and common correlated effects pooled estimation procedures. The analysis accounts also for the existence of fiscal rules in place, their features, and their interaction with the budget balance. In the absence of fiscal rules, the twin deficit hypothesis is confirmed. The size of the estimated coefficient on the budget balance is between 0.68 and 0.79. However, the existence of fiscal rules strongly reduces the effect of budget balance on the current account balance (the coefficient is reduced to 0.1). In fact, the twin deficits relationship does not hold with some specific kinds of rules: debt rules, rules with monitoring of compliance, as well as budget balance rules and debt rules in emerging market economies and lowest income countries, and in the post-crisis period.

Cost of Banking Crises: Does the Policy Framework Matter?

This paper empirically investigates how the stringency of macroeconomic policy frameworks impacts the unconditional cost of banking crises. We consider monetary, fiscal and exchange rate policies. A restrictive policy framework may promote stronger banking stability, by enhancing discipline and credibility, and by giving financial room to policymakers. At the same time though, tying the hands of policymakers may be counterproductive and procyclical, especially if it prevents them from responding properly to financial imbalances and crises. Our analysis considers a sample of 146 countries over the period 1970-2013, and reveals that extremely restrictive policy frameworks are likely to increase the expected cost of banking crises. By contrast, by combining discipline and flexibility, some policy arrangements such as budget balance rules with an easing clause, intermediate exchange rate regimes or an inflation targeting framework may significantly contain the cost of banking crises. As such, we provide evidence on the benefits of “constrained discretion” for the real impact of banking crises.

Flexible fiscal rules and countercyclical fiscal policy

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.

Flexible Fiscal Rules and Countercyclical Fiscal Policy

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 Rules at a Glance: Country Details from a New Dataset

This paper provides country-specific information on fiscal rules in use in 81 countries from 1985 to end-September 2012. It serves as background material and update of the July 2012 Working Paper “Fiscal Rules in Response to the Crisis—Toward the ‘Next Generation’ Rules: A New Dataset” and is also available in an easy accessible electronic data visualization tool (http://www.imf.org/external/datamapper/FiscalRules/map/map.htm.).The dataset covers four types of rules: budget balance rules, debt rules, expenditure rules, and revenue rules, applying to the central or general government or the public sector. It also presents details on various characteristics of rules, such as their legal basis, coverage, escape clauses, as well as key supporting features such as independent monitoring bodies.