## howtonote1809

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---

### Structural Balance Rules
- Definition and purpose:
  - Extend cyclically-adjusted rules by correcting revenue and spending for one-off fiscal measures and other economic cycles, such as those related to asset or commodity prices.
- Advantages:
  - Can provide greater economic stabilization than cyclically-adjusted balance rules.
  - Prevent spending of one-off revenues or revenues related to an asset price boom, reducing spending volatility.
  - Particularly valuable for countries where business cycles are not the main source of macroeconomic fluctuations (for example, commodity exporters).
- Challenges and limitations:
  - Monitoring and computation are more complicated than for cyclically-adjusted rules.
  - Designation of one-offs is challenging and hinges on perceptions about the temporary nature of measures; policymakers may have incentives to classify measures strategically.
  - Identifying nonstandard cycles (for example, commodity price cycles) is difficult; determining whether commodity price changes are temporary or structural is challenging and creates technical complications (IMF 2012).
- One-offs:
  - Defined as large, nonrecurrent measures whose impact on fiscal balances usually falls predominantly in the year when such measures take place and that entail no sustained change in the intertemporal budget position.
  - Examples: revenue windfalls (receipts from sale of concessions), sales of telecommunication licenses, transfers of profits from the central bank, exceptional spending interventions (emergency relief after a natural disaster).

### Over-the-Cycle Budget Balance Rules
- Definition and assessment:
  - Require attainment of a given nominal budget balance ceiling on average over the cycle; limit is set and assessed as an average over years encompassing all stages of the business cycle.
  - Expansion measured from trough of previous cycle to peak of current; contraction from peak to trough of current cycle.
- Stabilization properties:
  - Tend to have stronger stabilization properties than cyclically-adjusted or structural balance rules.
  - Can accommodate automatic stabilizers and discretionary fiscal measures.
- Trade-offs and risks:
  - Greater flexibility may come at the expense of credibility: can allow excessively loose or tight fiscal policy at various times, potentially difficult to reverse later.
- Computational and enforcement challenges:
  - Peaks and troughs and distances between them are unknown until the cycle is complete; rules must be assessed after the cycle, limiting real-time monitoring.
  - Corrective measures can be taken only after end of cycle.
  - Assessing compliance requires precise dating of the cycle; methodology to identify turning points and stability of national accounts data matters.
  - Dating business cycles involves judgment, which can be controversial and undermine enforcement.
  - Example: United Kingdom’s former over-the-cycle golden rule—UK Treasury was criticized for re-dating the cycle in 2005 (starting period moved from 1999 to 1997), adding two years to the beginning of the cycle and putting the government back on course to meet the golden rule (Chote, Emmerson, and Tetlow 2009).

### Expenditure Rules
- Forms and horizons:
  - Set limits on total, primary, or current spending; limits apply to nominal or real expenditure.
  - Typically set in absolute terms (levels) or growth rates, occasionally as percent of GDP, with time horizon typically 3 to 5 years (Lledó and others 2017).
- Advantages:
  - Easier to understand, monitor, and enforce because they target budget parts governments control directly and that are visible to the public.
  - Exhibit higher compliance rates than most other rules (Cordes and others 2015).
- Vulnerabilities:
  - Not immune to creative accounting (for example, higher reliance on tax expenditures commonly excluded from coverage).
  - Can induce lower levels of public investment; rules do not specify which spending types to contain, leading to excessive cuts in capital spending—particularly acute in developing economies with weak public financial management.
- Stabilization and design considerations:
  - Expenditure rules defined in levels or growth rates (real or nominal) can support macroeconomic stabilization by constraining spending during temporary booms when windfall revenues are high.
  - Excluding cyclically sensitive expenditure items (for example, unemployment benefits) can increase countercyclicality.
  - Expenditure rules set as a ratio of GDP tend to be procyclical, unless defined relative to potential rather than actual GDP growth.
  - Defining targets in relation to potential GDP retains countercyclical properties of cyclically adjusted balance rules with fewer measurement errors.
- Real versus nominal targets:
  - Nominal expenditure targets:
    - More transparent, easier to monitor and enforce.
    - Better economic stabilization properties because they incorporate inflation developments.
  - Real expenditure targets:
    - Compliance is not affected by inflation, reducing stabilization effect.
    - Require assumptions about projected inflation to convert real targets into nominal ceilings, opening door to strategic manipulation of deflators.
    - Inflation forecast errors can create conflicts between the rule and budget constraints during the fiscal year.
- Ensuring debt sustainability:
  - Basic expenditure rules that do not take the revenue side into account have only partial impact on debt dynamics.
  - In low revenue-to-GDP ratio countries, simple expenditure rules can weaken fiscal sustainability incentives by discouraging revenue mobilization.
  - More sophisticated designs can overcome limitations; example cited is the European Union’s expenditure benchmark which allows expenditure to grow above the limit if higher spending is matched by increases in discretionary revenue.

### Revenue Rules
- Definitions and types:
  - Set floors or ceilings on government income proceeds.
  - Relatively rare compared with other rule types.
- Examples and numeric values:
  - WAEMU revenue floor in 2015: 20 percent of GDP.
  - Kenya’s revenue limit: 21 percent to 22 percent of GDP.
  - Netherlands’ windfall revenue rule (established 2011): requires that 50 percent of additional tax revenues not anticipated in the multiyear path agreed by coalition partners be used to reduce public debt, under certain conditions.
  - Denmark: direct and indirect taxes were capped between 2001 and 2011.
  - Australia: tax revenues as proportion of GDP prevented from being raised between 1985 and 1988.
- Trade-offs:
  - Revenue floors might require tax hikes in bad times, exacerbating fiscal procyclicality (especially when floors are expressed in level terms, not percent of GDP).
  - Revenue ceilings can limit revenue mobilization and government savings in good times.
  - Neither revenue floors nor ceilings constrain spending directly, so they do not by themselves ensure fiscal sustainability.
- Use of windfall revenues:
  - Some rules dictate earmarking of higher-than-expected revenues for debt reduction or deficit reduction (Netherlands, Lithuania).
  - Lithuania’s rule (in force since 2008): larger-than-projected revenues in any fiscal year must be used to reduce the deficit of the general government.

### The European Union’s Expenditure Benchmark (Box 1)
- Main features:
  - Sets a ceiling on annual growth of primary spending equal to the medium-term rate of potential GDP growth (EC 2017).
  - Introduced as part of the 2011 Stability and Growth Pact reform.
  - Expenditure defined in nominal primary terms (total spending excluding interest payments) and corrected for the cycle by excluding unemployment benefits.
- Application rules:
  - Annual limit applies to the net growth of primary spending—that is, growth not financed by corresponding changes in discretionary revenue measures.
  - Rationale: to preserve debt sustainability, increases in spending above potential GDP must be financed by additional revenue measures.
  - The benchmark prevents higher-than-expected revenues from being spent, provided they do not stem from discretionary tax policy measures.
- Relationship with structural balance rules:
  - Used to assess compliance with the structural balance rule called the medium-term objective under the preventive arm of the Stability and Growth Pact.
  - Broad (but not exact) equivalence with the structural balance rule is noted under specific elasticity conditions.

### Analytical Tools and Approaches for Fiscal Rule Selection
- Purpose:
  - Tools simulate impact of a rule on deficit and debt dynamics; some models use metrics such as volatility of macroeconomic variables and price dynamics.
- Available materials:
  - The note is accompanied by Excel and EViews files for the first three methods; a fourth (model-based) method requires advanced programming skills.
- Counterfactual analysis (first approach):
  - “Rewriting history” by producing a retrospective scenario where a rule is assumed introduced at some past point; typically assumes government spending plays the adjustment role to comply with the rule.
  - Difficulty: counterfactual spending paths affect other macroeconomic variables, including GDP.
- Scenario analysis (forward-looking):
  - Simulates effect of rules over the forecasting horizon under baseline and several shock scenarios.
  - Shock scenarios in IMF (2009) include:
    - low growth: real GDP growth remains below trend and the output gap widens throughout the simulation horizon;
    - large shock: output gap widens rapidly and then narrows progressively;
    - boom-bust: rapid growth for a few years followed by a sharp decline;
    - contingent liability shock: debt rises suddenly by 15 percentage points.
  - Challenge: ensure feedback from fiscal variables to output is taken into account.
- Stochastic simulations:
  - Shocks drawn from a distribution representing past data behavior; procedure repeated (for example, a thousand simulations) to derive fan charts.
  - Fan charts depict confidence bands around the median projection and allow probabilistic assessment of fiscal stance and debt dynamics.
  - Example: under a structural balance rule in the United Kingdom, the probability that debt would fall below 60 percent of GDP by 2026 is about 50 percent.
- Model-based rule selection:
  - Uses multi-country macroeconomic models (for instance, medium-scale DSGE) incorporating intertemporal decisions, general equilibrium effects, and expectations.
  - Advantage: can simulate combinations of rules; examples include IMF (2009) GIMF simulations and Andrle and others (2015) GIMF work.

### Fiscal Multipliers, Measurement Errors, and Short-Term Output Costs
- Introduction of a rule is associated with a tighter fiscal stance and is likely to have a negative effect on output, at least in the short term; simulations should incorporate fiscal multipliers.
- Some macroeconomic variables are subject to large ex post revisions; assessment should account for measurement errors.
- Example: cyclically adjusted balance rule can allow excessive expenditure when potential output is overestimated in real time and revised downward ex post.
- Empirical comparison: Andrle and others (2015) compare expenditure and structural balance rules for Italy and France using a fiscal multiplier and both real-time and ex post data; public debt would have been significantly lower under the rules, but the structural balance rule is more sensitive to measurement errors on potential output.

### Rules for Commodity Exporters
- Primary objectives:
  - (1) Stabilization given volatility of commodity prices, and (2) fiscal sustainability and equitable intergenerational allocation given resource depletion.
- Rule types and features:
  - Revenue split rules: set aside a certain percentage of revenues using an ad hoc criterion (e.g., save revenues above the amount initially budgeted or the average of past revenues).
  - Price smoothing rules: use a reference price; save the difference when actual revenues exceed reference revenues so only “reference revenues” are available to the budget.
  - Structural balance rules: correct nominal balance for the output gap and the commodity gap defined as (P − P*) / P*, where P and P* denote current and structural commodity prices.
  - Expenditure rules: limit growth of government spending in nominal or real terms or in percent of nonresource GDP.
- Limitation:
  - Revenue-only rules may not constrain borrowing; excessive spending financed by borrowing can still deteriorate fiscal position. Expenditure and structural balance rules more directly stabilize expenditure.

### Rules for Resource-Rich Countries: Fiscal Sustainability and Intergenerational Equity
- Framework:
  - Primary framework is the permanent income hypothesis (PIH).
  - PIH implication: intertemporal budget constraint satisfied when the nonresource primary deficit is constant and equal to the return on total wealth (financial plus resource wealth).
- Rule variants:
  - Target on the nonresource primary balance (as a share of nonresource GDP) equal to real return on accumulated financial wealth plus implicit real return on NPV of future resource revenues.
  - “Bird-in-hand” rule: spend only the return accruing from accumulated financial assets; resource revenues fully saved except for interest they generate.
  - Modified PIH: allow initial scaling up of investment temporarily before stabilizing in the medium term.

### Rules for Other Developing Countries: Volatility, Operational Constraints, and Development Needs
- Key constraints:
  - (1) Volatile macroeconomic environment, (2) difficulties stabilizing public expenditure, (3) large development needs.
- Coping with volatility:
  - Nominal balance rules transmit revenue volatility to spending and are generally unsuitable.
  - Cyclically-adjusted balance rules do not filter out terms-of-trade shocks or structural changes and are subject to unstable estimates.
  - Structural balance rules can correct for additional volatility sources but are difficult to compute and monitor.
  - Simple spending rules are often preferred for shielding spending from revenue volatility.
- Technical and operational difficulties:
  - Identifying business cycle state is statistically difficult due to output volatility and structural breaks.
  - Poor debt and cash management systems hinder steady funding flows necessary for smoothing spending.
  - Limited access to borrowing requires self-insurance (building financial buffers in good times).
- Addressing development needs:
  - Golden rule drawbacks: weakens link to gross debt, opens creative accounting, may constrain productivity-enhancing spending.
  - Alternative: ceiling on current expenditure combined with a nominal balance rule or ceiling on total expenditure to create an indirect floor for capital spending.
  - Well-designed MTBF and strong public investment framework can help protect capital spending.

### Preliminary Assessment and General Principles for Developing Countries
- Data and institutional shortfalls limit first-best rules; spending rules or simple revenue-split rules to build buffers are often the only suitable options.
- Trade-offs between simplicity and flexibility are more stark in developing countries; the cost of a simple suboptimal rule may be less than risks from complex, ill-measured rules.
- In high macroeconomic volatility and pronounced data gaps, an expenditure rule capping expenditure growth often balances simplicity, stabilization, operational guidance, and ease of monitoring.
- In countries with strong borrowing constraints and weak debt/cash management, room for smoothing expenditure is limited and self-insurance may be among the few feasible options.

### Lessons from Theoretical Literature on Fiscal Rules
- Theoretical vs. practical rules:
  - Theoretical models define optimal fiscal policies as those maximizing social welfare and typically assume debt sustainability; practical rules are permanent constraints on fiscal aggregates.
- Public debt sustainability models:
  - Sovereign debt contracts are hard to enforce, enabling self-fulfilling debt crises and “bad equilibria.”
  - Credible fiscal rules can reduce debt after negative shocks and help avoid bad equilibria.
- Economic stabilization models (DSGE with neo-Keynesian frictions):
  - Optimal fiscal policy often proxied by simple policies with welfare close to complex policies.
  - Optimal degree of fiscal stabilization depends on monetary policy constraints and initial debt level; guidance differs across normal times, high debt, and zero lower bound scenarios.
- Political economy models:
  - Fiscal rules can constrain fiscal discretion and mitigate biases toward high deficits and debt from political processes.
- Limitations of theoretical models:
  - Many models do not analyze debt sustainability and economic stabilization simultaneously and often assume credible long-term government commitment.
  - These limitations push policymakers toward pragmatic rule design emphasizing operational feasibility and country-specific adaptation.

*Source: HOW TO SELECT FISCAL RULES: A PRIMER, International Monetary Fund | December 2017*

### 0.5 percent of potential output on average (Eyraud

### howtonote1809 - 0.5 percent of potential output on average (Eyraud

### Structural Balance Rules
- Definition and purpose:
  - Structural balance rules extend cyclically-adjusted rules by correcting revenue and spending for one-off fiscal measures and other economic cycles, such as those related to asset or commodity prices.
- Advantages:
  - Can provide greater economic stabilization than cyclically-adjusted balance rules.
  - Prevent spending of one-off revenues or revenues related to an asset price boom, reducing spending volatility.
  - Particularly valuable for countries where business cycles are not the main source of macroeconomic fluctuations (for example, commodity exporters).
- Challenges and limitations:
  - Monitoring and computation are more complicated than for cyclically-adjusted rules.
  - Designation of one-offs is challenging and hinges on perceptions about the temporary nature of measures; policymakers may have incentives to classify measures strategically (retain revenue-enhancing measures; exclude balance-deteriorating ones).
  - Identifying nonstandard cycles (for example, commodity price cycles) is difficult; determining whether commodity price changes are temporary or structural is a challenging call and creates technical complications (IMF 2012).
- One-offs:
  - Defined in the source as large, nonrecurrent measures whose impact on fiscal balances usually falls predominantly in the year when such measures take place and that entail no sustained change in the intertemporal budget position.
  - Examples include revenue windfalls (receipts from sale of concessions), sales of telecommunication licenses, transfers of profits from the central bank, and exceptional spending interventions (emergency relief after a natural disaster).

### Over-the-Cycle Budget Balance Rules
- Definition and assessment:
  - Require attainment of a given nominal budget balance ceiling on average over the cycle.
  - The limit is set and assessed as an average over years encompassing all stages of the business cycle (expansionary and contractionary phases). Expansion measured from trough of previous cycle to peak of current; contraction from peak to trough of current cycle.
- Stabilization properties:
  - Tend to have stronger stabilization properties than cyclically-adjusted or structural balance rules.
  - Can accommodate automatic stabilizers and discretionary fiscal measures (stimulus or contraction).
- Trade-offs and risks:
  - Greater flexibility may come at the expense of credibility: can allow excessively loose or tight fiscal policy at various times, potentially difficult to reverse later.
- Computational and enforcement challenges:
  - Peaks and troughs and distances between them are unknown until the cycle is complete; rules must be assessed after the cycle, limiting real-time monitoring.
  - Corrective measures can be taken only after end of cycle.
  - Assessing compliance requires precise dating of the cycle; methodology to identify turning points and stability of national accounts data matters.
  - Dating business cycles involves judgment, which can be controversial and undermine enforcement.
  - Example: United Kingdom’s former over-the-cycle golden rule—UK Treasury was criticized for re-dating the cycle in 2005 (starting period moved from 1999 to 1997), adding two years to the beginning of the cycle and putting the government back on course to meet the golden rule (Chote, Emmerson, and Tetlow 2009).

### Expenditure Rules
- Forms and horizons:
  - Set limits on total, primary, or current spending; limits apply to nominal or real expenditure.
  - Typically set in absolute terms (levels) or growth rates, occasionally as percent of GDP, with time horizon typically 3 to 5 years (Lledó and others 2017).
- Advantages:
  - Easier to understand, monitor, and enforce because they target budget parts governments control directly and that are visible to the public.
  - Exhibit higher compliance rates than most other rules (Cordes and others 2015).
- Vulnerabilities:
  - Not immune to creative accounting (for example, higher reliance on tax expenditures commonly excluded from coverage).
  - Can induce lower levels of public investment; rules do not specify which spending types to contain, leading to excessive cuts in capital spending—particularly acute in developing economies with weak public financial management.
- Stabilization and design considerations:
  - Expenditure rules defined in levels or growth rates (real or nominal) can support macroeconomic stabilization by constraining spending during temporary booms when windfall revenues are high.
  - Excluding cyclically sensitive expenditure items (for example, unemployment benefits) can increase countercyclicality.
  - Expenditure rules set as a ratio of GDP tend to be procyclical (allow fast increase in expenditure in good times and force spending declines in bad times), unless defined relative to potential rather than actual GDP growth.
  - Defining targets in relation to potential GDP retains countercyclical properties of cyclically adjusted balance rules with fewer measurement errors.
- Real versus nominal targets:
  - Nominal expenditure targets:
    - More transparent, easier to monitor and enforce.
    - Better economic stabilization properties because they incorporate inflation developments (requiring downward real spending adjustment when inflation rises and upward when inflation falls, providing countercyclical response).
    - Consistency between the rule and the budget ceiling is ensured and is not affected by revision of inflation forecasts.
  - Real expenditure targets:
    - Compliance is not affected by inflation, which reduces stabilization effect.
    - Require assumptions about projected inflation to convert real targets into nominal ceilings; translation opens door to strategic manipulation of deflators to obtain additional spending room.
    - Inflation forecast errors can create conflicts between the rule and budget constraints during the fiscal year; downward revisions in inflation can allow excessive real spending under nominal ceilings unless sudden adjustments are made.
- Ensuring debt sustainability:
  - Basic expenditure rules that do not take the revenue side into account have only partial impact on debt dynamics.
  - In low revenue-to-GDP ratio countries, simple expenditure rules can weaken fiscal sustainability incentives by discouraging revenue mobilization.
  - More sophisticated designs can overcome limitations; example cited is the European Union’s expenditure benchmark which allows expenditure to grow above the limit if higher spending is matched by increases in discretionary revenue.

### Revenue Rules
- Definitions and types:
  - Set floors or ceilings on government income proceeds.
  - Relatively rare compared with other rule types.
- Examples and numeric values:
  - WAEMU revenue floor in 2015: 20 percent of GDP.
  - Kenya’s revenue limit: 21 percent to 22 percent of GDP.
  - Netherlands’ windfall revenue rule (established 2011): requires that 50 percent of additional tax revenues not anticipated in the multiyear path agreed by coalition partners be used to reduce public debt, under certain conditions.
  - Denmark: direct and indirect taxes were capped between 2001 and 2011.
  - Australia: tax revenues as proportion of GDP prevented from being raised between 1985 and 1988.
- Trade-offs:
  - Revenue floors might require tax hikes in bad times, exacerbating fiscal procyclicality (especially when floors are expressed in level terms, not percent of GDP).
  - Revenue ceilings can limit revenue mobilization and government savings in good times.
  - Neither revenue floors nor ceilings constrain spending directly, so they do not by themselves ensure fiscal sustainability.
- Use of windfall revenues:
  - Some rules dictate earmarking of higher-than-expected revenues for debt reduction or deficit reduction (Netherlands, Lithuania), which can mitigate deficit bias and procyclical bias provided windfalls occur mainly during booms.
  - Lithuania’s rule (in force since 2008): larger-than-projected revenues in any fiscal year must be used to reduce the deficit of the general government.

### The European Union’s Expenditure Benchmark (Box 1)
- Main features:
  - Sets a ceiling on annual growth of primary spending equal to the medium-term rate of potential GDP growth (EC 2017).
  - Introduced as part of the 2011 Stability and Growth Pact reform.
  - Expenditure defined in nominal primary terms (total spending excluding interest payments) and corrected for the cycle by excluding unemployment benefits.
- Application rules:
  - Annual limit applies to the net growth of primary spending—that is, growth not financed by corresponding changes in discretionary revenue measures.
  - Rationale: to preserve debt sustainability, increases in spending above potential GDP must be financed by additional revenue measures.
  - The benchmark prevents higher-than-expected revenues from being spent, provided they do not stem from discretionary tax policy measures.
- Relationship with structural balance rules:
  - Used to assess compliance with the structural balance rule called the medium-term objective under the preventive arm of the Stability and Growth Pact.
  - There is broad (but not exact) equivalence between the expenditure benchmark and the structural balance rule: if structural revenues’ elasticity to trend GDP is 1 and spending elasticity is zero, then maintaining expenditure growth in line with trend GDP can preserve a given structural balance. (Source presents a formal expression: SB = (R_s – E_s)/Y_s = φ – E/Y_s and differentiates ΔSB = 0 ⇔ dE/E = dY_s/Y_s.)

### Analytical Tools for Fiscal Rule Selection
- Purpose:
  - Tools simulate impact of a rule on deficit and debt dynamics; some models also use metrics such as volatility of macroeconomic variables (output, employment, public expenditure, private consumption) and price dynamics (interest rates and inflation).
- Available materials:
  - The note is accompanied by a series of Excel and EViews files for the first three methods; a fourth (model-based) method requires advanced programming skills to run simulations.
- Counterfactual analysis (first approach):
  - “Rewriting history” by producing a retrospective scenario where a rule is assumed introduced at some past point; analyzes how government behavior and economic indicators would have changed and what today’s outcomes would be.
  - Typically assumes government spending plays the adjustment role to comply with the rule.
  - Difficulty: counterfactual spending paths affect other macroeconomic variables, including GDP.

*Source: HOW TO SELECT FISCAL RULES: A PRIMER, International Monetary Fund | December 2017*

### introduction of a rule is associated with a tighter fiscal

### howtonote1809 - introduction of a rule is associated with a tighter fiscal stance

### Fiscal multipliers, measurement errors, and short-term output costs
- Introduction of a rule is associated with a tighter fiscal stance and is likely to have a negative effect on output, at least in the short term; simulations should incorporate fiscal multipliers to avoid overestimating the benefits of the rule.
- Some macroeconomic variables are subject to large ex post revisions; assessment of fiscal rules should take into account possible measurement errors.
- Example: the cyclically adjusted balance rule can allow excessive expenditure when potential output is overestimated in real time and revised downward ex post; assessing performance using only ex post data may overstate benefits.
- Empirical comparison: Andrle and others (2015) compare expenditure and structural balance rules for Italy and France using a fiscal multiplier and both real-time and ex post data; public debt would have been significantly lower under the rules, but the structural balance rule is more sensitive to measurement errors on potential output.

### Approaches to assessing fiscal rules
- Counterfactual approach
  - Compares historical outcomes with hypothetical implementation of a rule; must incorporate fiscal multipliers and measurement error considerations.

- Scenario analysis (forward-looking)
  - Simulates the effect of rules over the forecasting horizon under a baseline and several shock scenarios.
  - Shock scenarios in IMF (2009) include:
    - low growth: real GDP growth remains below trend and the output gap widens throughout the simulation horizon;
    - large shock: output gap widens rapidly and then narrows progressively;
    - boom-bust: rapid growth for a few years followed by a sharp decline;
    - contingent liability shock: debt rises suddenly by 15 percentage points.
  - Challenge: ensure feedback from fiscal variables to output is taken into account.

- Stochastic simulations
  - Shocks are drawn from a distribution representing past data behavior (joint distribution calibrated via VAR or multivariate normal law).
  - Procedure: draw consistent macroeconomic paths → let fiscal policy adjust according to the rule → generate projections for fiscal aggregates → repeat (for example, a thousand simulations) to derive fan charts.
  - Fan charts depict confidence bands around the median projection and allow probabilistic assessment of fiscal stance and debt dynamics.
  - Example result: under a structural balance rule in the United Kingdom, the probability that debt would fall below 60 percent of GDP by 2026 is about 50 percent.

- Model-based rule selection
  - Uses multi-country macroeconomic models (for instance, medium-scale DSGE) that incorporate intertemporal decisions, general equilibrium effects, and expectations.
  - Simulations can be conducted around the steady state or a baseline forecast; shocks can be ad hoc or based on past data.
  - Advantage: can simulate combinations of rules rather than assessing rules individually.
  - Examples:
    - IMF (2009) GIMF simulations for three stylized economies (small open advanced, large open advanced, small open commodity-exporting) with domestic demand, productivity, and external demand shocks; plots deviations from steady state over a 15-year horizon for GDP, inflation, debt, deficit, tax revenues, and interest expenditure.
    - Andrle and others (2015) use GIMF for European economies with stochastic aggregate demand shocks drawn from historical output gap variability; rule selection relies on variance analysis around steady state for output, debt, fiscal balance, and risk premium.

### Rules for commodity exporters
- Two primary objectives to consider: (1) stabilization given volatility of commodity prices, and (2) fiscal sustainability and equitable intergenerational allocation given resource depletion.
- Rules to cope with price volatility and achieve macroeconomic stability:
  - Revenue split rules: set aside a certain percentage of revenues using an ad hoc criterion (e.g., save revenues above the amount initially budgeted or the average of past revenues; or save a predetermined percentage of commodity revenues).
  - Price smoothing rules: split revenues using a reference price; save the difference when actual revenues exceed reference revenues so only “reference revenues” are available to the budget; reference prices from automatic formulas (for example, average of past and future prices) or independent committees.
  - Structural balance rules: correct nominal balance for the output gap and the commodity gap defined as (P − P*) / P*, with P and P* denoting current and structural prices for the commodity; structural balance measures the fiscal position if GDP were at potential and commodity prices at their long-term/structural level. If the structural balance rule ceiling is set at zero, government can spend only its “structural revenues” every year.
  - Expenditure rules: limit growth of government spending in nominal or real terms or in percent of nonresource GDP; useful to contain spending growth during price booms and reduce procyclicality.
- Limitation: revenue-only rules may not constrain borrowing; excessive spending financed by borrowing can still deteriorate fiscal position. Expenditure rules and structural balance rules more directly stabilize expenditure.

### Rules to ensure fiscal sustainability and intergenerational equity (resource-rich countries)
- Use fiscal sustainability analysis for resource-rich countries; primary framework is the permanent income hypothesis (PIH).
- PIH implications:
  - Intertemporal budget constraint satisfied when the nonresource primary deficit is constant and equal to the return on total wealth (financial plus resource wealth).
  - The fixed nonresource primary deficit benchmark can be expressed in real terms, in real terms per capita, or as a share of nonresource GDP; provides an estimate of “sustainable” expenditure.
- Rules discussed:
  - Target on the non-resource primary balance (as a share of nonresource GDP) corresponding to the sum of real return on accumulated financial wealth and implicit real return on NPV of future resource revenues.
  - “Bird-in-hand” rule: only the return accruing from accumulated financial assets (interest income) is spent; resource revenues fully saved except for interest they generate.
  - Modified PIH or fiscal sustainability frameworks allow initial scaling up of investment (relaxing the nonresource primary deficit temporarily) before stabilizing in the medium term; rule may apply after the initial scaling-up period.

### Rules for other developing countries: volatility, operational constraints, and development needs
- Three characteristics affecting rule design: (1) volatile macroeconomic environment, (2) difficulties stabilizing public expenditure, (3) large development needs.
- Coping with a volatile environment:
  - Developing countries face deeper and more frequent recessions and larger/longer expansions than advanced economies; revenues affected by exchange rate fluctuations, terms-of-trade shocks, weather, natural disasters, volatile external financing, and structural transformations.
  - Nominal balance rules transmit revenue volatility to spending and are generally unsuitable. Cyclically-adjusted balance rules do not filter out terms-of-trade shocks or structural changes and are subject to unstable estimates; structural balance rules can correct for additional volatility sources but are difficult to compute and monitor.
  - Simple spending rules are often preferred for shielding spending from revenue volatility.
- Technical and operational difficulties stabilizing spending:
  - Technical issues: identifying business cycle state is statistically difficult due to output volatility and structural breaks; concept of business cycle may be less relevant when shocks are noncyclical; data limitations constrain advanced estimation techniques requiring high-frequency indicators.
  - Operational constraints: poor debt and cash management systems hinder steady funding flows necessary for smoothing spending; limited ability to borrow domestically or internationally in bad times; segmentation of fund sources and revenue earmarking impede smoothing.
  - In cases of significant borrowing constraints, self-insurance (building financial buffers in good times, e.g., stabilization funds) may be the only option.
  - Expenditure rules can work where access to financial markets is easier; some expenditure rules have good stabilization properties and are simple to implement.
- Addressing large development needs:
  - Emerging market and low-income countries frequently need to protect or increase public investment and spending on education, health, and social security.
  - Golden rule drawbacks: weakens link to gross debt, opens creative accounting, may constrain productivity-enhancing spending.
  - Alternative: impose ceiling on current expenditure combined with a nominal balance rule or ceiling on total expenditure to create an indirect floor for capital spending while maintaining limits on capital compared with the golden rule.
  - Well-designed MTBF and strong public investment framework can help protect capital spending from being cut to comply with fiscal rules.

### Preliminary assessment and general principles for developing countries
- Data and institutional shortfalls limit first-best rules; spending rules or simple revenue-split rules to build buffers are often the only suitable options.
- Trade-offs between simplicity and flexibility are more stark in developing countries; cost of a simple suboptimal rule may be less than risks from complex, ill-measured rules.
- In high macroeconomic volatility and pronounced data gaps, an expenditure rule capping expenditure growth often balances simplicity, stabilization, operational guidance, and ease of monitoring.
- In countries with strong borrowing constraints and weak debt/cash management, room for smoothing expenditure is limited and self-insurance may be among the few feasible options.

### Lessons from the theoretical literature on fiscal rules
- Rule objectives and design in theory versus practice:
  - Theoretical models define optimal fiscal policies as those maximizing social welfare and typically assume debt sustainability; policymakers use rules to ensure debt sustainability in practice.
  - Theoretical fiscal rule: a stable policy reaction function linking fiscal instruments to macro indicators; policy reacts predictably. Practical fiscal rule: permanent constraint on fiscal aggregates limiting discretion.
- Public debt sustainability models:
  - Sovereign debt involves contracts that are hard to enforce, enabling self-fulfilling debt crises and “bad equilibria” that raise risk premia and interest rates.
  - Credible fiscal rules can reduce debt after negative shocks and help avoid bad equilibria. Example theoretical rule: s_t = (1 − γ) s_{t−1} + γ(α0 + α1 b_t); high values of parameter α1 can be sufficient to eliminate bad equilibria.
- Economic stabilization models (DSGE with neo-Keynesian frictions):
  - Optimal fiscal policy can often be proxied by simple policies (linear functions of a few macro indicators) with welfare close to complex policies.
  - Optimal degree of fiscal stabilization depends on monetary policy constraints and initial debt level:
    - Normal times with unconstrained monetary policy and low debt: optimal reaction is to fully offset cyclical revenue decline with spending cuts, keeping nominal balance and debt ratio constant (spending cuts preferred to tax increases).
    - If spending cuts infeasible or debt is high: use a mix of higher borrowing and tax hikes, allowing a higher but stable debt-to-GDP ratio; let automatic stabilizers operate at least partially.
    - When monetary policy constrained by the zero lower bound: optimal fiscal policy should be more countercyclical; expenditure should not fall as much and may increase depending on shock size.
- Political economy models:
  - Fiscal rules can constrain fiscal discretion and mitigate biases toward high deficits and debt from political processes (short-term orientation, opportunistic preelection spending, optimistic forecasts, common pool problems, fiscal illusion).
  - Political economy models justify existence of rules but are often stylized and abstract from stabilization and debt sustainability concerns.
- Limitations of theoretical models for fiscal rule design:
  - Most models do not analyze debt sustainability and economic stabilization simultaneously.
  - Many models assume credible long-term government commitment; time inconsistency and lack of commitment reduce direct applicability of theoretical optimal-policy prescriptions.
  - These limitations have led policymakers to adopt pragmatic rule design criteria, emphasizing operational feasibility and country-specific adaptation.

*Italic: Source: howtonote1809 - introduction of a rule is associated with a tighter fiscal (PDF chapter/section).*

### References

### References

### Fiscal rules, fiscal governance, and debt dynamics
- Adam, K. 2011. “Government Debt and Optimal Monetary and Fiscal Policy.” European Economic Review 55: 57–74.
- Alesina, A., and R. Perotti. 1999. “Budget Deficits and Budget Institutions.” In Fiscal Institutions and Fiscal Performance, edited by J. Poterba and J. Von Hagen. Chicago: The University of Chicago Press. (1999): 13–36.
- Alesina, A., and G. Tabellini. 1990. “A Positive Theory of Fiscal Deficits and Government Debt.” Review of Economic Studies 57: 403–14.
- Alesina, A., and G. Tabellini. 1990b. “Voting on the Budget Deficit.” American Economic Review 80 (1): 37–49.
- Andrle, M., J. Bluedorn, L. Eyraud, T. Kinda, P. Koeva Brooks, G. Schwartz, and A. Weber. 2015. “Reforming Fiscal Governance in the European Union.” IMF Staff Discussion Note 15/09, International Monetary Fund, Washington, DC.
- Cordes, T., T. Kinda, P. Muthoora, and A. Weber. 2015. “Expenditure Rules: Effective Tools for Sound Fiscal Policy.” IMF Working Paper 15/29, International Monetary Fund, Washington, DC.
- Debrun, X., and L. Jonung. 2017. “Rules-Based Fiscal Policy: How Sustainable Is It?” IMF Working Paper (forthcoming), International Monetary Fund, Washington, DC.
- Kopits, G. (editor). 2004. Rules-Based Fiscal Policy in Emerging Markets Background, Analysis and Prospects. Palgrave Macmillan, New York.
- Kopits, G., and S. Symansky. 1998. Fiscal Policy Rules. IMF Occasional Paper 162, International Monetary Fund, Washington, DC.
- Lledó, V., S. Yoon, X. Fang, S. Mbaye, and Y. Kim. 2017. “Fiscal Rules at a Glance.” Background note for the publication of the IMF Fiscal Rules Database. http:// www .imf .org/ external/ datamapper/ FiscalRules/ map/ map .htm
- Mbaye, S., and H. E. Ture, 2018, “What Makes Fiscal Rules Effective: Lessons from Case Studies”, IMF Working Paper, International Monetary Fund, Washington.
- Schaechter, A., T. Kinda, N. Budina, and A. Weber. 2012. “Fiscal Rules in Response to the Crisis—Toward the Next-Generation Rules. A New Dataset.” IMF Working Paper 12/187, International Monetary Fund, Washington, DC.
- Servén, L. 2007. “Fiscal Rules, Public Investment, and Growth.” Policy Research Working Paper Series 4382, World Bank, Washington, DC.
- Tapsoba, R. 2012. “Do National Numerical Fiscal Rules Really Shape Fiscal Behaviours in Developing Countries? A Treatment Effect Evaluation.” Economic Modelling 29 (4): 1356–69.
- Valencia, F. 2015. “Strengthening Mexico’s Fiscal Framework.” Selected Issues Papers. IMF Country Report 15/314, International Monetary Fund, Washington, DC.

### Procyclicality, stabilization, and fiscal policy design
- Balassone, F., and D. Franco. 2000. “Public Investment, the Stability Pact, and the Golden Rule.” Fiscal Studies 21 (2): 207–29.
- Balassone, F., and M. Kumar. 2007. “Addressing the Procyclical Bias.” In Promoting Fiscal Discipline. M. Kumar and T. Ter-Minassian editors. International Monetary Fund, Washington, DC. (2007): 36–57.
- Bergman, U. M., and M. Hutchison. 2015. “Economic Stabilization in the Post-Crisis World— Are Fiscal Rules the Answer?” Journal of International Money and Finance 52: 82–101.
- Bova, E., N. Carcenac, and M. Guerguil. 2014. “Fiscal Rules and the Procyclicality of Fiscal Policy in the Developing World.” IMF Working Paper 14/122, International Monetary Fund, Washington, DC.
- Frankel, J., C. Vegh, and G. Vuletin. 2013. “On Graduation from Fiscal Procyclicality.” Journal of Development Economics 100 (1): 32–47.
- Guerguil, M., P. Mandon, and R. Tapsoba. 2017. “Flexible Fiscal Rules and Countercyclical Fiscal Policy.” Journal of Macroeconomics 52: 189–220.
- Ilzetzki, E., and C. A. Vegh. 2008. “Procyclical Fiscal Policy in Developing Countries: Truth or Fiction?” NBER Working Paper 14191, The National Bureau of Economic Research, Cambridge.
- Konuki, T., and M. Villafuerte. 2016. “Cyclical Behavior of Fiscal Policy Among Sub-Saharan African Countries.” IMF African Department Paper Series, International Monetary Fund, Washington, DC, available at https:// www .imf .org/ external/ pubs/ ft/ dp/ 2016/ afr1604 .pdf
- Frankel, J., C. Vegh, and G. Vuletin. 2013. “On Graduation from Fiscal Procyclicality.” Journal of Development Economics 100 (1): 32–47.

### Public investment, public finances, and resource-rich country frameworks
- Baunsgaard, T., M. Villafuerte, M. Poplawski-Ribeiro, and C. Richmond. 2012. “Fiscal Frameworks for Resource Rich Developing Countries.” IMF Staff Discussion Note 12/04, International Monetary Fund, Washington, DC.
- Blanchard, O., and F. Giavazzi. 2004. “Improving the SGP Through a Proper Accounting of Public Investment.” Discussion Paper 4220, Centre for Economic and Policy Research, London.
- Bornhorst, F., A. Fedelino, J. Gottschalk, and G. Dobrescu. 2011. “When and How to Adjust Beyond the Business Cycle—A Guide to Structural Fiscal Balances.” IMF Technical Notes and Manuals 2011/02, International Monetary Fund, Washington, DC.
- International Monetary Fund (IMF). 2012. “Macroeconomic Policy Frameworks for Resource Rich Developing Countries.” IMF Policy Paper and supplements. International Monetary Fund, Washington, DC.  https:// www .imf .org/ external/ np/ pp/ eng/ 2012/ 082412 .pdf  and  https:// www .imf .org/ external/ np/ pp/ eng/ 2012/ 082412a .pdf and  https:// www .imf .org/ external/ np/ pp/ eng/ 2012/ 082412b .pdf.
- IMF. 2015. “Making Public Investment More Efficient.” IMF Policy Paper, International Monetary Fund, Washington, DC,  available  at  http:// www .imf .org/ external/ np/ pp/ eng/ 2015/ 061115 .pdf.
- IMF. 2016. “Macroeconomic Developments and Prospects in Low-Income Developing Countries—2016.” IMF Policy Paper, International Monetary Fund, Washington, DC, available  at  https:// www .imf .org/ en/ Publications/ Policy -Papers/ Issues/ 2017/ 01/ 13/ PP5086 -Macroeconomic -Developments -and -Prospects -in -Low -Income -Developing -Countries -2016
- Servén, L. 2007. “Fiscal Rules, Public Investment, and Growth.” Policy Research Working Paper Series 4382, World Bank, Washington, DC.
- Calderón, C., and R. Fuentes. 2010. “Characterizing the Business Cycles of Emerging Economies.” Policy Research Working Paper 5343, World Bank, Washington, DC.
- Calderón, C., and K. Schmidt-Hebbel. 2008. “Business Cycles and Fiscal Policies: the Role of Institutions and Financial Markets.” Working Paper 481, Central Bank of Chile, Santiago.

### Measurement, models, and estimation methods
- Blagrave, P., R. Garcia-Saltos, D. Laxton, and F. Zhang. 2015. “A Simple Multivariate Filter for Estimating Potential Output.” IMF Working Paper 15/79, International Monetary Fund, Washington, DC.
- Bi, R., H. Qu, and J. Roaf. 2013. “Assessing the Impact and Phasing of Multi-Year Fiscal Adjustment: A General Framework.” IMF Working Paper 13/182, International Monetary Fund, Washington, DC.
- Fernandez-Villaverde, J., J. F. Rubio-Ramirez, and F. Schorfheide. 2016. “Solution and Estimation Methods for DSGE Models.” NBER Working Paper 21862, The National Bureau of Economic Research, Cambridge.
- Girouard, N., and C. André. 2005. “Measuring Cyclically Adjusted Budget Balances for OECD Countries., OECD Economics Department Working Paper 434, Organisation for Economic Co-operation and Development, Paris.
- Fedelino, A., M. Horton, and A. Ivanova. 2009. “Computing Cyclically Adjusted Balances and Automatic Stabilizers,” IMF Technical Notes and Manuals 2009/05, International Monetary Fund, Washington, DC.
- Escolano, J. 2010. “A Practical Guide to Public Debt Dynamics, Fiscal Sustainability, and Cyclical Adjustment of Budgetary Aggregates.” IMF Technical Notes and Manuals 2010/02, International Monetary Fund, Washington, DC.
- Correia, I., E. Farhi, J. P. Nicolini, and P. Teles. 2013. “Unconventional Fiscal Policy at the Zero Bound.” American Economic Review 103 (4): 1172–211.
- Leeper, E. M., L. Campbell, and D. Liu. 2016. “Optimal Time-Consistent Monetary, Fiscal and Debt Maturity Policy.” SSRN Electronic Journal, Social Science Research Network, Rochester,  available  at  https:// ssrn .com/ abstract = 2719457.
- Fernandez-Villaverde, J., J. F. Rubio-Ramirez, and F. Schorfheide. 2016. “Solution and Estimation Methods for DSGE Models.” NBER Working Paper 21862, The National Bureau of Economic Research, Cambridge.

### Sovereign debt, default risk, and financial interactions
- Aguiar, M., and M. Amador. 2014. “Sovereign Debt.” Handbook of International Economics Vol 4. Elsevier. (2014): 647–87.
- Caballero, R., and A. Krishnamurthy. 2004. “Fiscal Policy and Financial Depth.” NBER Working Paper 10532, The National Bureau of Economic Research, Cambridge.
- Cuadra, G., J. M. Sanchez, and H. Sapriza. 2013. “Fiscal Policy and Default Risk in Emerging Markets.” Review of Economic Dynamics 13 (2): 452–69.
- Hatchondo, J. C., L. Martinez, and F. Roch. 2017. “Fiscal Rules and the Sovereign Default Premium.” Unpublished, Washington, DC.
- Lorenzoni, G., and I. Werning. 2013. “Slow Moving Debt Crises.” NBER Working Paper 19228, The National Bureau of Economic Research, Cambridge.
- Ostry, J., A. Ghosh, and R. Espinoza. 2015. “When Should Public Debt Be Reduced?” IMF Staff Discussion Note 15/10, International Monetary Fund, Washington, DC.

### Country studies, institutional reports, and policy notes
- Caceres, C., and M. Ruiz-Arranz. 2010. “What Fiscal Rule Would Work Best for the UK?” United Kingdom: Selected Issues Paper. IMF Country Report 10/337, International Monetary Fund, Washington, DC.
- Chote, R., C. Emmerson, and G. Tetlow. 2009. “The Fiscal Rules and Policy Framework.” In The IFS Green Budget. Chote, R., Emmerson, C., Miles, D. and Shaw, J. editors. Institute for Fiscal Studies, London. (2009): 81–112.
- Emmerson, C., C. Frayne, and S. Love. 2006. “The Government’s Fiscal Rules.” IFS Briefing Note 16, Institute for Fiscal Studies, London.
- Petrova, I. 2012. “Iceland’s Policy Objectives Under a New Fiscal Rule.” In Iceland: Selected Issues. IMF Country Report 12/90, International Monetary Fund, Washington, DC.
- European Commission (EC). 2016. “Report on Public Finances in EMU.” Institutional Paper 045, European Commission, Brussels.
- European Commission (EC). 2017. “Vade Mecum on the Stability and Growth Pact, 2017 Edition.” Institutional Paper 052, European Commission, Brussels.
- International Monetary Fund (IMF). 2009. “Fiscal Rules—Anchoring Expectations for Sustainable Public Finances.” International Monetary Fund, Washington, DC. https:// www .imf .org/ external/ np/ pp/ eng/ 2009/ 121609 .pdf
- International Monetary Fund (IMF). 2013. Public Financial Management and Its Emerging Architecture, edited by M. Cangiano, T. Curristine, and M. Lazare. International Monetary Fund, Washington, DC.
- International Monetary Fund (IMF). 2014. Fiscal Monitor: Public Expenditure Reform—Making Difficult Choices. International Monetary Fund, Washington, DC, April.
- International Monetary Fund (IMF). 2017. “A Greater Role for Fiscal Policy.” In Fiscal Monitor—Achieving More with Less. International Monetary Fund, Washington, DC, April.
- International Monetary Fund (IMF). 2018. “How to Calibrate Fiscal Rules. A Primer” IMF How-To-Note, International Monetary Fund, Washington, DC, available  at  https:// www .imf .org/ en/ Publications/ SPROLLs/ How -To -Notes
- Kopits, G. (editor). 2004. Rules-Based Fiscal Policy in Emerging Markets Background, Analysis and Prospects. Palgrave Macmillan, New York.
- OECD. 2008. OECD Economic Surveys: Germany. Paris: OECD Publishing.  http:// dx .doi .org/ 10 .1787/ eco _surveys -deu -2008 -en.

*Source: howtonote1809 - References (howtonote1809 - References)*

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_Source: https://www.imf.org/-/media/files/publications/howtonotes/howtonote1809.pdf_