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Mr. Steven A. Symansky
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A number of advanced and developing economies have adopted, or are planning to adopt, rules that impose a permanent constraint on fiscal policy—expressed as a numerical ceiling or target—in terms of summary indicators of overall fiscal performance. The rationale for fiscal policy rules (mainly in the form of various balanced-budget rules, borrowing rules, and debt rules) rests primarily on the need for macroeconomic stability, support of other financial policies, long-term sustainability, reduction of negative spillovers, and overall policy credibility. In principle, most of these objectives can be met with discretionary fiscal measures—if sought by a farsighted electorate—within the context of an annual budget or a medium-term adjustment plan. However, many fiscal consolidation programs undertaken to correct the persistent budget deficits experienced over the past two decades have been less than successful, suggesting that, although discretionary policies may be theoretically superior, well-designed fiscal policy rules may offer a useful second-best solution to counter political pressures on fiscal policymaking. Indeed, the strongest case for fiscal rules can be made on political economy grounds, namely, that the rules are useful in correcting the bias of democratically elected governments to run budget deficits and to accumulate public debt at the expense of future generations. In technical terms, a major advantage of rules-based fiscal policy over discretionary policy is time consistency.
A number of advanced and developing economies have adopted, or are planning to adopt, rules that impose a permanent constraint on fiscal policy—expressed as a numerical ceiling or target—in terms of summary indicators of overall fiscal performance. The rationale for fiscal policy rules (mainly in the form of various balanced-budget rules, borrowing rules, and debt rules) rests primarily on the need for macroeconomic stability, support of other financial policies, long-term sustainability, reduction of negative spillovers, and overall policy credibility. In principle, most of these objectives can be met with discretionary fiscal measures—if sought by a farsighted electorate—within the context of an annual budget or a medium-term adjustment plan. However, many fiscal consolidation programs undertaken to correct the persistent budget deficits experienced over the past two decades have been less than successful, suggesting that, although discretionary policies may be theoretically superior, well-designed fiscal policy rules may offer a useful second-best solution to counter political pressures on fiscal policymaking. Indeed, the strongest case for fiscal rules can be made on political economy grounds, namely, that the rules are useful in correcting the bias of democratically elected governments to run budget deficits and to accumulate public debt at the expense of future generations. In technical terms, a major advantage of rules-based fiscal policy over discretionary policy is time consistency.
Fiscal policy rules can be implemented under a variety of institutional arrangements. Although the statutory basis usually consists of a constitutional, legal, or treaty provision, it may be equally effective in the form of a regulation or a policy guideline. In fact, the instrument selected by a given country is largely a function of custom, legal precedent, or convention. Enforcement and monitoring of compliance preferably are to be exercised by an authority independent of the executive branch of government. There are cases, however, where the department or agency responsible for budget execution, under the authority of the ministry of finance, can be entrusted with this function if subject to sufficient public accountability and transparency. A critical aspect of a fiscal rule is the method of implementation, consisting of the following elements: whether the rule imposes only an ex ante obligation or also an ex post requirement of compliance; the availability of contingency measures during the budget execution; the provision for safeguards or escape clauses; and the effectiveness of penalties for noncompliance.
Actual experience with fiscal policy rules, albeit limited, has been mixed. Prohibition or limits on government access to central bank financing can be useful, especially in developing and transition economies, for restraining inflationary pressures. Prohibition on domestic government borrowing also can be effective, through lower interest rates, in inducing investment and contributing to sustained growth, although at the risk of increased external indebtedness. Recently, the convergence toward the EMU reference value on government deficits seems to have contributed to significant downward pressure on interest rates, especially in some highly indebted EU member countries—confirming the sensitivity of interest rates to balanced-budget rules observed in the U.S. states. However, as with many fiscal adjustment episodes (including those based on a discretionary approach), fiscal rules often have been met through cuts in investment expenditures, tax increases, and various one-off measures, rather than through lasting structural reform of public finances. Thus, given these design and operational problems, the potential contribution of fiscal rules to sustained growth has not been fully realized.
Evidence from subnational governments in the United States indicates that adherence to a balanced-budget rule has little or no influence on output variance. This finding is supported by simulations performed on advanced economies; these simulations show that the variability of output associated with a deficit ceiling or a no-deficit rule—envisaged, respectively, under EMU and the proposed U.S. constitutional amendment—is only slightly larger than in the absence of a rule with automatic stabilizers fully allowed to operate. Similarly, targeting a public debt ratio, with room for accumulation or drawdown of contingency reserves, provides sufficient flexibility.
As part of their favorable effect on sustainability, well-designed fiscal rules—as compared with discretionary policies, which lack time consistency—can confer important credibility gains, reflected in cheaper access to financial markets and in increased support from the electorate. To achieve credibility, policymakers must display commitment through compliance with the rule in a transparent manner, instead of through recourse to creative accounting or exploitation of institutional ambiguities. Credibility is created on the basis of both a satisfactory track record of compliance with the rule and commitment to future policy measures, including necessary structural reform, to support the rule.
Based on the above assessment, it is plausible to identify the principal characteristics of an ideal fiscal rule. Such a rule should be well defined as to the selected indicator, institutional coverage, and escape clauses; highly transparent; adequate with respect to the specified goal; consistent internally as well as with other macroeconomic policies; sufficiently simple in the eyes of the public; flexible enough to accommodate cyclical fluctuations and exogenous shocks; enforceable in the given environment; and supported by efficient policies, including structural reforms, rather than one-off measures. Although in some cases rules-based policies have been introduced to correct severe macroeconomic imbalances, in general it is preferable to follow a gradual convergence—through a multiyear fiscal adjustment—prior to adopting a fiscal rule.
In the context of surveillance and program design, the IMF has been inclined to support the adoption of rules by a member country in broad conformity with the above characteristics if the basic conditions for fiscal discipline already prevail. Indeed, it has been necessary to temper encouragement with caution as to the possible risks, absent such conditions. If requested, the IMF stands ready to provide technical assistance in the design and operation of fiscal policy rules, as well as in the implementation of measures to support such rules.
