Fiscal Rules Research Articles

The Effects of Fiscal Rules on Mexico’s Municipalities: Looking at Fiscal Behavior Changes

ABSTRACT This paper evaluates the fiscal effects of the Financial Discipline Law for States and Municipalities (LDFEM, in Spanish) on Mexican local governments. As a public financial management (PFM) reform, the LDFEM is an agency solution that establishes a national fiscal rule to align subnational fiscal behavior and achieve a sustainable fiscal position in all states and municipalities. This paper uses a quasi-experimental research design to explore the effects of complying with the LDFEM on financial conditions–budget balances and debt management. The findings suggest improvements in budget balances and debt costs and no impact on variations in debt obligations.

The Impact of Federal Fiscal Rules on Debt: Insights from the European Union Countries

AbstractThis study analyzes the impact of federal fiscal rules on government debt in European Union countries. We describe the growth and institutional reforms of fiscal rules in European Union countries and conduct an empirical analysis to examine their impact on central government debt to draw comparative implications for federal fiscal rules in the United States. Our empirical results suggest that more stringent expenditure rules can reduce central or federal government debt relative to GDP, while other types of fiscal rules are found to be insignificant. We also find that certain design and structural features of fiscal rules are more important than others. Our findings offer timely and pertinent policy implications for the mounting federal budget and debt challenges of the United States.

Sidestepping the Sovereign Debt Trap? The Case of Poland

ABSTRACT We show that a sovereign debt trap can be sustained – even long term – provided economic growth that would be, if there was no sovereign debt, sufficiently high both in absolute terms and relative to fiscal deficit. While sustainable, the trap may still be as costly (or even more) as fiscal crises, as suggested by the case of Italy and Japan. We also show, based on data for Poland, how easy it is to fall into the trap. In particular, even a transitory slowdown may permanently raise the debt-to-GDP ratio. This might be the case even for government bond yields permanently lower than nominal GDP growth and forgoing some primary spending. The risk that Poland will fall into the trap is compounded by a projected permanent slowdown, circumvention of fiscal rules (if continued), and small corporate and financial sectors limiting the government’s ability to increase taxes without further dampening economic growth. As measures to cut that risk, we argue for growth enhancing reforms and strengthening fiscal rules. The latter would counteract the “war of attrition” and resolve the time inconsistency of a balanced budget policy, which we analyze by modifying the Barro–Gordon model.

Electoral Cycles in Fiscal Rules: International Empirical Evidence

Abstract Using panel data from 99 countries over the period of 1985–2020, this study aims to uncover that fiscal rules work in electoral cycles. The results show that fiscal rules are less likely to be implemented in the pre-election year. We also find that this loosening in fiscal rules is especially prominent in cases when the incumbent political party can wield significant political power, where countries are less developed economically and politically, and where the management of fiscal rules is more likely to be exposed to discretionary interventions. Our findings are aligned with the opportunistic political budget cycles, in which politicians exploit fiscal policies and systems to serve their own political incentives. These results suggest that even fiscal rules, which are designed to prevent political pressure, are also subject to political process. (JEL codes: D72, D78, E32, E62, H11, and H60).

Do Fiscal Rules Tame the Political Taxation Cycles under Authoritarian Regimes: Evidence from China’s New Budget Law

Political budget cycles (PBCs) in Western democracies have been extensively examined. Yet, few studies have explored whether there exists a local political budget cycle under authoritarian regimes. Moreover, the question of whether fiscal rules effectively tame the political taxation cycles remains. Unlike previous studies, we bring the “business” back into the study of political “business” cycles. Using firm tax payments data in China, we confirm the presence of political cycles in local tax collection behaviors under the authoritarian system. However, in contrast to the fiscal manipulation behaviors during and before political elections in Western democracies, Chinese local leaders engage in opportunistic taxation behaviors in the early years after the Provincial Congress of the Communist Party (PCCP) when there are local leaders’ elections. The political taxation cycles disappeared following the implementation of China’s new budget law in 2015, demonstrating the effectiveness of fiscal rules in taming local political budget cycles in authoritarian regimes. This research extends the existing PBC theory to the context of non-Western democracies based on micro-level evidence.

Under Treasury Control: Japan’s Emergence as an Egalitarian, Small-government State

This study analyses the formation of a policy system that reduced income inequality in Japan in the 1960s, a period of rapid economic growth. According to comparative research, the Japanese state is an example of small government with income equality. Japan’s income inequality rose in the 1950s, and at that point, the government faced a decision about how to reduce income inequality, and particularly whether to expand social security and government size. This study uses primary materials to analyse how and why Japan became more egalitarian while maintaining a small-government state, focusing on fiscal rules set by the Ministry of Finance, which adopted a balanced budget rule that prevented the issuance of public bonds and limited the tax burden ratio. As reflected in the government’s Income Doubling Plan, this development led to a trade-off among factors, such as social security, public works, and tax cuts, which led to the subordination of social security. Despite public debt issuance in 1965, which was contrary to two fiscal rules, social security did not expand because of fiscal rigidification. Throughout the 1960s, spending on public works and income tax cuts was prioritised over social security, resulting in small government but also income equality.

Intermediate inputs in Dutch disease. Copper in Chile

PurposeBy means of a practical model, the paper discusses the role of intermediate inputs in the ability of a booming extractive sector to draw resources out of lagging sectors, giving rise to Dutch disease. MethodsThe model is for the Chilean economy and follows an ‘extended’ input-output structure, with 35 production sectors. Once calibrated and parameterized, the model can be solved numerically to estimate the resource movement effect and the spending effect of a copper boom. FindingsThe numerical exercises show that, when the use of intermediate inputs is taken into account, the resource movement effect is of similar magnitude to the spending effect in explaining deindustrialization in Dutch disease. The key mechanism here is that, when the copper sector expands, its effects on real wages and good prices can be significant, due to the use of intermediate inputs. ImplicationThis implies that the policies that are commonly recommended to avoid Dutch disease (fiscal rules, sovereign wealth funds, etc.) may not be very effective if they are not accompanied by others aimed at promoting greater provision or efficient use of scarce resources. OriginalityThe present study contributes to the literature on Dutch disease in two ways. On the one hand, it provides an estimate of the resource movement effect and the spending effect of a commodity boom. On the other hand, it provides evidence in favour of the hypothesis that extractive activities can lead to direct deindustrialization.

EU Economic Governance as a Supranational Determinant of Health Inequalities in the Eurozone

The COVID-19 pandemic raises the question of austerity's problematic social toll for health in the south of Europe. Has EU economic governance constrained health spending? If so, have these spending levels led to inequalities, which in turn shaped responses to the pandemic? EU economic governance is often dismissed as ineffective because of its poor track record of compliance. Yet austerity is blamed for negative health outcomes. This article shows that the EU fiscal rule is a determinant of health because it affects fiscal policies of European countries. First, the analysis of EU member states during 1995–2018 shows that austerity policies affect health spending and health inequalities. Euro-area countries under the EU Excessive Deficit Procedure significantly consolidated their health spending. The contractionary effect was concentrated in southern countries, contributing to rising health inequalities across the core and periphery. Finally, the analysis shows the pandemic implications of health inequalities, as periphery countries with a track record of high consolidation display more stringent (and costly) COVID-19 response models. This analysis contributes to understanding the supranational determinants of health in the EU, showing the pervasive spillover effects of the fiscal framework on national health policies.

Social dialogue in defining the European Union economic and social strategy

Following very significant initiatives, such as the European Pillar of Social Rights and its Action Plan, the Commission presented in 2023 its Communication on Strengthening social dialogue in the European Union: harnessing its full potential for managing fair transitions, together with a Proposal for a Recommendation to the Council on strengthening social dialogue. The present analysis will discuss the progress and limitations of these initiatives, such as the lack of binding nature of the legal instruments used or their effect on policymaking. In this regard, particular attention will be paid to the insertion of social dialogue into European economic and social governance mechanisms. To this end, the study deals with the influence of the economic governance framework on the role and development of social dialogue in the most recent transformations that have taken place since the 2008 crisis to the present. Likewise, the role given to social dialogue will be analysed in the new fiscal rules and economic governance framework recently approved.

Fiscal Rules, Corruption and Electoral Accountability

Fiscal Rules, Corruption and Electoral Accountability

Debt Sustainability Analysis in Reformed EU Fiscal Rules

Debt Sustainability Analysis in Reformed EU Fiscal Rules

Fiscal rules, capital controls, and cross-border financial integration

This paper shows that adopting fiscal rules (FRs) decreases the use of capital controls and increases cross-border financial integration. This result is robust to alternative measures of fiscal rules, capital controls, and international financial integration — it is also robust to alternative econometric approaches. It also shows that the adoption of fiscal rules increases financial integration. This paper innovatively employs a formal instrumental variables (IV) approach to tackle the endogeneity of the decision to adopt fiscal rules. The adoption of FRs is instrumented using the age dependency ratio (ADR). This strategy is particularly effective because adopting FRs is more likely when the ADR is relatively low, a finding well established in the empirical literature. Governments impose capital controls to channel domestic savings into the public sector, finance their excessive fiscal deficits, and reduce their borrowing costs. However, the uncertainty over the government's future fiscal policies may lead to capital flight. FRs ‘tie the hands’ of governments and induce them to commit themselves to fiscal discipline. Moreover, FRs can also reduce the government's borrowing costs. These effects of FRs render capital controls less necessary and lead policymakers to lift capital controls, resulting in higher cross-border financial integration.

One rule fits all? Heterogeneous fiscal rules for commodity exporters when price shocks can be persistent: Theory and evidence

One rule fits all? Heterogeneous fiscal rules for commodity exporters when price shocks can be persistent: Theory and evidence

National fiscal rules, Maastricht fiscal criteria and non-linear public debt dynamics in Serbia

National fiscal rules, Maastricht fiscal criteria and non-linear public debt dynamics in Serbia

The Role of Fiscal Rules and Their Effectiveness in Achievement of Macroeconomic Stability

The Role of Fiscal Rules and Their Effectiveness in Achievement of Macroeconomic Stability

International fiscal rules and domestic support for austerity

In recent decades, fiscal integration in Europe has manifested through restrictive rules. However, the consolidation of public finances often encounters citizens’ resistance. International obligations can raise public support for costly domestic policies that are consistent with the obligations’ terms, but can European fiscal pledges influence public opinion and boost support for austerity? I fielded an original survey experiment in Italy and manipulated information about the existence of a new fiscal rule, national or European, mandating austerity measures. In stark contrast with extant research, I find no evidence that the source of the fiscal rule matters when measuring respondents’ support for austerity. This result suggests that the effect of international pledges on garnering public support for costly domestic measures wanes if these measures directly burden citizens’ financial well-being. Moreover, relinquishing fiscal autonomy in favour of new European rules appears unlikely to aid politicians in winning public endorsement for an austerity agenda.

Fiscal financing with labour markets frictions

AbstractIn this paper, we study the effect of search and matching frictions, i.e., equilibrium unemployment, on fiscal financing decisions in the United States. We build a Real Business Cycle model with labour market frictions and a rich set of fiscal tools and estimate the model using Bayesian methods on US data for various fiscal rule specifications. Most importantly, we find that the model with unemployment, output and debt in the fiscal rules fits the data best. Under the fiscal rule that best fits the data, the reaction of fiscal instruments to output and debt are significantly quantitatively different than a rule that ignores unemployment. Fiscal instruments react stronger to cyclical factors except transfers. These changes also affect model dynamics in response to fundamental non‐fiscal shocks.

Fiscal rules and economic cycles: Quality (always) Matters

This paper investigates the role of fiscal rules in managing public debt, particularly focusing on their efficacy during different phases of economic cycles. Analyzing Balance, Expenditure, and Debt Fiscal Rules, the study finds that their impact on debt reduction is significantly influenced by the quality of the fiscal framework and the economic cycle phase. Moreover, factors like legal basis, procedural framework, and political stability are identified as key to ensuring compliance with fiscal objectives. Our results suggest that fiscal rules are most effective in reducing debt during positive economic cycles, with the design and institutional support playing a crucial role. This has important policy implications, particularly in the context of the debt increase after the Covid-19 pandemic.

Determinants of fiscal rules policy credibility in West African Economic and Monetary Union countries

Determinants of fiscal rules policy credibility in West African Economic and Monetary Union countries

Do debt relief and fiscal rules improve public debt sustainability? The experience of sub-Sahara African countries

The sub-Sahara African (SSA) region accounts for 33 of the 39 Highly Indebted Poor Countries (HIPCs) with many of these countries facing challenges in public debt management. This paper examines issues that are key to improving the debt situation in the region. Specifically, the study investigates two key questions namely whether the adoption of fiscal rules and debt relief improve public debt sustainability. What factors reduce the public debt of SSA countries? Interestingly, the findings reveal that while debt relief improves debt sustainability, the imposition of fiscal rules threatens the debt sustainability of the region. Further, higher economic growth and increasing government balance are instrumental to reducing public debt. These findings have far-reaching policy implications for public debt management in developing countries.