## Chile’s experience shows the value of building the right framework for fiscal policy

## Source details

**Canonical URL:** [Chile’s experience shows the value of building the right framework for fiscal policy](https://www.imf.org/-/media/files/publications/fandd/article/2022/march/larrain.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/fandd/article/2022/march/larrain.pdf.md)
- [Structured JSON version](/-/media/files/publications/fandd/article/2022/march/larrain.pdf.json)

---

### Overview
- Fiscal institutions are crucial for every country and especially for resource-intensive economies.
- Institutional fiscal frameworks proved especially important during the COVID-19 pandemic for enabling large and timely fiscal responses.

### Impact of institutional frameworks during COVID-19
- Countries with responsible fiscal conduct before the pandemic were better able to:
  - strengthen health systems;
  - deliver fiscal transfers, subsidies, and guarantees;
  - achieve faster recovery from the shock.
- Evidence reported: aggressive fiscal responses had positive effects on stock markets, currencies, industrial production, employment, confidence, and sovereign risk premiums (Deb and others 2021).
- The efficacy of fiscal measures was greater in advanced economies and in those with lower public debt.
- Examples and comparisons:
  - Chile, described as the world’s 43rd largest economy, was able to increase outlays or forgo revenue by more than 10 percent of GDP—on roughly the same scale as Germany, Japan, the United Kingdom, and the United States.
  - The poorest countries in Africa, the Americas, and Asia bolstered spending or forwent revenue by less than 2.5 percent of GDP, implying a slower and more painful recovery.

### Why fiscal frameworks matter
- Without an institutional fiscal framework, government spending is primarily constrained by current-year public resources (mainly tax revenue) and limited borrowing capacity.
- Fiscal revenues tend to be procyclical; spending financed with current revenues and constrained credit exacerbates economic cycles.
- Adverse macroeconomic effects include increased volatility in the exchange rate, inflation, and interest rates, with negative repercussions for investment, economic growth, and employment.
- Resource-intensive economies face amplified problems because fiscal revenues also depend on commodity prices:
  - Commodity exports typically account for over 60 percent—and in some cases more than 90 percent—of total exports in such economies.

### Elements of a suitable fiscal framework
- The framework should be composed of at least three elements:
  - Fiscal rule:
    - Adopt a medium- to long-term perspective.
    - Example approach: annual fiscal balance targets based on the country’s capacity to generate long-term or structural revenues rather than current revenues.
    - Save extra funds during booms for use in down cycles.
  - Sovereign wealth fund:
    - Save extra revenues from resource price booms.
    - Invest in a diversified, highly liquid portfolio, normally in international markets.
    - Make funds available for use based on objective criteria during economic crises.
  - Independent fiscal institutions:
    - Establish and strengthen autonomous fiscal councils to advise governments and legislatures.
    - Provide technical recommendations, macro-fiscal projections, and assessments of fiscal sustainability.
    - Contribute to public debate and sound the alarm about fiscal risks from economic and political decisions.

### Evidence, design considerations, and best practices
- Joint analysis by Chile’s Ministry of Finance and the IMF (Larraín, Ricci, and Schmidt-Hebbel 2019) found increased adoption of fiscal rules by emerging market and developed economies.
- Key findings:
  - Fiscal discipline is necessary because governments face an intertemporal budget constraint; fiscal rules reinforce that discipline.
  - Fiscal rules can be efficient tools contributing to fiscal sustainability, solvency, and economic performance.
  - Growing empirical evidence indicates fiscal rules tend to improve fiscal performance.
- Caveats and design guidance:
  - The efficacy of fiscal rules can be affected by complexity and noncompliance—observed in several Latin American countries.
  - Recommendations for fiscal rules: flexibility, simplicity, transparency, and clear fiscal objectives.
  - Fiscal rules must be flexible to deal with unexpected shocks and should include a clear escape clause that:
    - Contains a quantitative definition of failure to meet fiscal targets.
    - Describes mechanisms and deadlines for a return to a sustainable fiscal path.
  - Some countries use rules limiting spending, public debt, or fiscal deficit; these may be less suitable for commodity-exporting emerging market economies but can complement a cyclically adjusted revenue rule, especially where debt is high or liabilities are rapidly accumulating.

### Post-pandemic challenges and policy priorities
- After the pandemic:
  - Governments will carry more debt.
  - Sovereign funds will be smaller.
  - Fiscal adjustments will be necessary in many cases to ensure sustainability.
- Policy priority:
  - Strengthening fiscal institutions should be an economic policy priority to ensure adjustments are organized, transparent, technically grounded, and minimize social impact.

*Felipe Larraín Bascuñan, “Chile’s experience shows the value of building the right framework for fiscal policy,” FINANCE & DEVELOPMENT, March 2022.*

---


_Source: https://www.imf.org/-/media/files/publications/fandd/article/2022/march/larrain.pdf_