## sdn1804-technical-background-papers ## Source details **Canonical URL:** [sdn1804-technical-background-papers](https://www.imf.org/-/media/files/publications/sdn/2018/sdn1804-technical-background-papers.pdf) ## Other formats - [Markdown version](/-/media/files/publications/sdn/2018/sdn1804-technical-background-papers.pdf.md) - [Structured JSON version](/-/media/files/publications/sdn/2018/sdn1804-technical-background-papers.pdf.json) --- ### Long-term trends in fiscal rules: adoption, multiplication, and resilience - Waves of adoption: - First wave: supranational rules surged in advanced economies during the early 1990s related to the 1992 Maastricht Treaty. - Second wave: early 2000s boom of national rules in emerging markets and supranational rules in some low-income countries. - Most recent wave: after the GFC, creation of rules at the national level (mainly in Europe). - Coverage and composition: - There are currently twice as many emerging market and developing economies than advanced countries with fiscal rules. - Since the 2000s, most new fiscal rule adopters have been low or middle-income economies. - Motivations differ across country groups (currency union requirements in advanced and low-income countries; commitment after crises in emerging markets—examples: Argentina, Brazil, Colombia, India, Pakistan, Chile, Mexico, Peru, Poland, Russia). - Multiplication and combinations: - The average number of rules has increased steadily over time with acceleration after the GFC. - Europe: average number of rules tripled from 2 to 6 in the past 15 years. - Outside the EU: average number of rules increased from zero to two during the same period. - By 2015 many non-European countries had three or more rules (including 17 countries in Sub Saharan Africa, and also Australia, Grenada, Mongolia and Peru). - Common combinations: budget balance rules and expenditure rules increasingly used with debt rules. - Rule duration and changes: - Median rule duration (adoption to rescission or present if not rescinded) has been around 9 years. - Supranational rules have been particularly resilient (European rules established in the 1990s remain); national rules have shorter life spans and are more often scrapped or replaced. - Notable European milestones: 3 percent of GDP deficit ceiling and 60 percent of GDP gross debt ceiling (1992); MTO structural balance rules (2005); required speed of debt reduction and “expenditure benchmark” (2011); transposition of MTOs into national law and correction mechanisms as part of the “Fiscal Compact” (2013). - Shocks testing resilience: 2008-10 GFC (almost a third of countries with national rules modified or put rules into abeyance); 2014-2015 commodity price collapse prompted many commodity exporters to revise rules. - New features since the GFC: - More escape clauses, cyclical adjustments, and clearer activation and return paths. - Enhanced monitoring and enforcement: formal sanctions, stronger legal bases, and independent fiscal councils. ### Second-generation fiscal rules: definition, flexibility, operationality, enforceability - Definition and scope: - Second-generation rules: those introduced in the past decade, generally evolving post-GFC; characterized as more (i) flexible, (ii) operational, and (iii) enforceable than the first generation. - Originated in Europe and have spread worldwide; they address shortcomings of pre-crisis rules rather than constituting a full paradigm shift. - More flexible (examples and mechanisms): - Escape clauses: - Pre-GFC escape clauses often lacked activation detail; post-GFC clauses are more widespread and specific. - European supranational framework (2011) introduced a general crisis clause for severe downturns in the euro area or EU. - Examples of well-defined escape clauses: Colombia (2011), Jamaica (2014), Grenada (2015). - Provisions for sustainability-improving reforms: - Allow temporary deviations for reforms with short-term costs but long-term fiscal benefits (pension reforms, public investment, structural reforms). - European SGP provisions since 2005 (pensions) and expanded in 2013-15 (public investment and structural reforms). - Mauritius (2008) debt rule allows temporary deviations for large public investment projects. - More operational: - Objective: clearer guidance targeting aggregates under policymakers’ control. - Expenditure rules: - Surge in adopters post-GFC. - European “expenditure benchmark” (2011) sets a ceiling on annual growth of primary spending. - EU national adopters: Austria, Croatia, Czech Republic, Greece, Italy, Spain. - Outside Europe: Mongolia (2013), Paraguay (2015), Brazil (2016) have caps on expenditure growth. - Fiscal effort rules: - Target discretionary fiscal actions; common indicator is cyclically-adjusted balance but alternatives exist. - Two alternative approaches: - Adjust fiscal balance beyond the output gap to correct for revenue windfalls/shortfalls (used in SGP corrective arm since 2011). Examples: Colombia (2011), Mongolia (2013) corrected for commodity price cycles. - Base computation on budget information (budget estimates of tax measures) rather than cyclical adjustments. Examples: “discretionary fiscal effort” indicator and the European “expenditure benchmark”. ### Monitoring, correction mechanisms, and institutional innovation - Fiscal councils and monitoring: - Prior to the GFC only Belgium had an independent fiscal council with a mandate to monitor rules. - Currently 31 countries have independent fiscal institutions assigned to monitor fiscal rules, 26 of which are EU members. - The European Fiscal Board established in 2015 to monitor supranational rules. - Outside the EU: Brazil, Chile, Colombia, Peru, and Serbia created independent institutions to monitor fiscal rules over the last five years. - Correction mechanisms — activation features: - Activation can be automatic (trigger) or discretionary; “automatic” describes trigger, not necessarily corrective actions. - Most mechanisms trigger ex post after a breach (e.g., European Fiscal Compact); some trigger ex ante when risk of breach is elevated (e.g., Poland). - Triggers can be quantitative (e.g., Slovakia’s debt thresholds) or qualitative (e.g., “significant deviation” assessments in Finland, Ireland, Italy, Belgium, France). - Triggers can be one-off year assessments or cumulative-deviation based (e.g., debt brakes in Germany, Jamaica, Grenada, Switzerland). - Correction mechanisms — corrective actions: - Range from restoring compliance with previous structural balance targets (Belgium, France, Portugal) to “overachieving” targets to offset past deviations (German and Swiss debt brakes). - Timeframes vary: - Belgium, Finland, France: corrective action within one and a half to two years. - Grenada: three years. - Slovakian rule: must submit a balanced budget to Parliament in the next fiscal year if debt is within three percentage points of GDP of the ceiling. - Policy-mix discretion varies: some allow any combination of revenue and expenditure measures (Germany, Switzerland); others mandate specific instruments (Slovakian across-the-board expenditure cut with exceptions). ### Empirical evidence: do fiscal rules improve fiscal balances? - Cross-country averages (raw correlation): - In a comprehensive sample of over 140 countries over 1985-2015, fiscal deficits averaged 2.1 percent of GDP without fiscal rules and 1.7 percent of GDP with fiscal rules. - Endogeneity concerns and IV strategy: - Endogeneity from reverse causality, omitted variables, and measurement error can bias OLS correlations. - Novel IV: diffusion-based instrument using adoption of fiscal rules in neighboring countries (number of neighboring countries adopting a fiscal rule in the previous year) and average fiscal rule strength in neighbors. - Identification assumption: neighbors’ rule adoption affects domestic adoption but affects domestic fiscal balance only through domestic rule adoption (possible violation if direct fiscal spillovers exist). - OLS and IV findings: - OLS: overall balances are higher by 0.8 percent of GDP in countries with fiscal rules on average (full sample). - IV (diffusion) results: - Fiscal Rule Dummy (IV): coefficient = 1.376 with (0.872) standard error (Table 4 Column 1); loses statistical significance once endogeneity is addressed but magnitude comparable to OLS. - Fiscal Rule Strength Index (IV): coefficient = 3.378** with (1.671) standard error (Table 4 Column 2) — positive and statistically significant. - Observations: 2,797 (Column 1); 2,526 (Column 2). - Kleinbergen-Paap rk test: 11.23 (Column 1); 43.70 (Column 2). - Stock-Wright p-value: 0.00 (both columns). - Interpretation: - Fiscal rules per se do not have a statistically significant causal impact on the fiscal balance once endogeneity is controlled with diffusion IVs. - Well-designed rules (measured by the strength index) have a statistically significant and positive impact on the fiscal balance. - IMF fiscal rules strength index (distributional stats): - Index equals zero for countries without rules; ranges from 0.1 (poorly designed) to 1 (well designed) for countries with rules. - Summary statistics reported (Table 1): - Obs. 1,296; Mean 0.294; Std. Dev. 0.140; Variance 0.020; Skewness 1.076. - Percentiles: 1% 0.107; 5% 0.116; 10% 0.132; 25% 0.181; 50% 0.259; 75% 0.375; 90% 0.484; 95% 0.570; 99% 0.738. - Note: “an average strength index of 0.26 (Table 1)” noted in text. - Countries with index above 0.8 include Lithuania, Latvia, Great Britain, the Netherlands and Romania. - Rule design heterogeneity (OLS evidence): - Poorly designed rules (first quartile) coefficient = 0.40 (0.46) — not statistically significant. - Better-designed rules (above first quartile) coefficient = 0.77*** (0.26) — statistically significant. - Moving from the 25th to the 75th percentile in the strength index (actual change = 0.19) implies an improvement of the budget balance by 0.64 percent of GDP (calculation described: 3.4 * 0.19). ### Distributional impacts: the 3 percent general government deficit ceiling in the EU - Sample and method: - 33 EU member and candidate countries from 1970 to 2016; focuses on the common numerical rule (3 percent deficit ceiling) and staggered adoption. - Four-step empirical approach: logit propensity, IPW counterfactual, ATET, and distributional comparisons (recover counterfactual densities and observations under additional assumptions). - Average effects (selection-corrected): - Difference-in-differences and IPW specifications: - Diff-in-diff 1 ATET: 1.17**; Std. error 0.66; P-value 0.09; Obs. 1,156. - Diff-in-diff 2 ATET: 2.29***; Std. error 0.78; P-value 0.01; Obs. 1,156. - IPW specifications produce smaller and statistically insignificant ATETs (IPW 1 ATET 0.99; IPW 2 ATET 0.56; IPW 3 ATET 0.07; IPW 4 ATET 0.42; various Std. errors and Obs. reported). - Conclusion: after correcting for selection into adoption, the average effect on the government balance is small and often statistically insignificant. - Distributional (magnet/bunching) effects: - The 3 percent deficit ceiling changed the entire shape of the deficit distribution: it narrowed the distribution by pulling large-deficit countries to reduce deficits and pulling high-balance countries toward the ceiling (a “magnet effect”). - Bunching range: from -4.2 percent of GDP to 2.8 percent of GDP (starts slightly below -3 percent ceiling). - Magnitude: 20 percent of the sample “bunches” around the 3 percent deficit ceiling in the treated group compared to the counterfactual; of this excess, 15 percent is located above the -3 percent ceiling (in compliance). - Country-level impacts: - Across 28 adopting countries, 22 countries saw their fiscal position improve; across these 22, government balances improved by 0.7 percent of GDP on average due to the rule. - Six countries (Luxembourg, Estonia, Sweden, Ireland, Finland, Denmark) saw average balances decrease by 0.5 percent of GDP. - France: average effect of the FR was a 0.95 percent of GDP improvement in the government balance. - Rank invariance assumption for country counterfactuals: - Assumes ordering of country-year observations is preserved when constructing counterfactuals; examples: Italy 1996 (observed deficit 6.75 percent of GDP; counterfactual 7.8 percent), Finland 2000 (observed surplus 6.9 percent; counterfactual 7.1 percent). - Rank invariance is strong but argued plausible due to persistence of fiscal behavior. - Policy implications: - Numerical rules can exert substantial distributional effects even when average effects are small. - Rules act as de facto targets (magnet), implying importance of careful calibration and consideration of state-dependent impacts (good times vs bad times). ### Compliance dynamics with budget balance rules (BBRs): threshold-reversion and mean reversion - Scope and data: - 55 national and 6 supranational BBRs across 49 countries between 1985 and 2016; focus on various BBR types (overall, primary, operational, structural, non-oil). - Economic compliance defined as dev_{i,j,t} = var_{i,j,t} − thrsd_{i,j,t} (percent of GDP); negative = noncompliance. - Six main empirical findings: - Threshold-reversion effect: deviations (positive and negative) tend to disappear over time; balances constrained by rules are pulled toward rule thresholds. - Asymmetry: reversion stronger for negative deviations (noncompliers) than for positive deviations (compliers). - Size and recurrence matter: stronger reversion for large infrequent negative deviations; weaker for small recurrent deviations. - Rule design and complementarities: better design or support from other rules does not uniformly increase pulling force; calibration of threshold relative to pre-rule mean matters more. - Stationarity: budget balances are stationary in most countries and converge to long-term means. - Threshold calibration: many BBR thresholds set close to pre-rule average balances (about two-thirds within one standard deviation). - Persistence and transition probabilities: - Deviations are persistent but not permanent: example Prob(dev_t < −5 | dev_{t−1} < −5) = 68 percent; positive deviations more likely to move closer to zero. - Econometric evidence (selected coefficients): - Baseline lagged deviation coefficient ≈ 0.72*** (0.07) — about 0.7 percentage points of a 1 percentage point previous deviation remain the following period. - Asymmetry: Lagged Deviation (Positive) coefficients around 0.80–0.91***; Lagged Deviation (Negative) coefficients around 0.34–0.82*** across specifications (standard errors reported). - Quadratic term: speed of convergence increases with size of negative deviation (negative-squared coefficient significant). - Threshold calibration effect: convergence faster when threshold set within one standard deviation of pre-rule mean (Lagged Deviation (Negative) X Threshold within 1 S.D. = -0.28* (0.17)). - Mean-reversion comparisons (with vs without rules): - Budget balances revert to long-term averages regardless of rules. - With rules: faster mean-reversion for negative deviations (reducing excessive deficits faster), but slower mean-reversion for positive deviations—rules thus help reduce deficit bias. - Selected coefficients from mean-reversion models: Lagged Deviation (Positive) ~ 0.51*** to 0.73*** across specifications; Lagged Deviation (Negative) ~ 0.75*** to 0.91***. - Policy messages: - Rules need not be strictly complied with to exert influence, especially for large infrequent deviations. - Calibration of thresholds matters more than many design features for ensuring deviations are quickly eliminated. - Serial non-compliance weakens the magnet effect; serial compliance strengthens it. ### Sovereign spreads and the cost of noncompliance: Excessive Deficit Procedure (EDP) evidence (EU) - Sample and main empirical finding: - 28 EU countries, 1999 to 2016. - Countries under EDP have sovereign spreads on average higher by 50 to 150 basis points compared to countries not under EDP. - Results robust to GMM estimation and extensive robustness checks. - EDP episodes and interpretation: - 174 EDP episodes in 1999–2016; 57 percent had real-time deficits above 3 percent ceiling. - Average duration of EDP ~ 5 years. - EDP provides forward-looking and multi-year information beyond in-year breaches. - Planned versus actual adjustment under EDP: - Median planned adjustment: 0.70 percent of GDP per year. - Actual delivered adjustment: 0.52 percent of GDP (3-year average change). - Non-EDP countries: median planned consolidation 0.17 percent of GDP; actual outcome deterioration of 0.29 percent of GDP. - Estimation approach: - System GMM to control endogeneity (lagged dependent variable, reverse causality). - Baseline controls: real GDP growth, inflation, short-term interest rate, net lending, public debt, EU VIX (VSTOXX), REER. - Heterogeneity and refinements: - Post-crisis effect: cost of EDP higher by about 40 basis points after 2009 in some specifications. - Euro-area subset: EDP associated with average higher spreads of 85 basis points in one specification. - Recurrent noncompliers: spreads higher by 114 basis points on average (cumulative count of EDP episodes). - Interpretations: - Benign: EDP gives markets valuable information on fiscal plans. - Less benign: EDP may signal weak discipline or create uncertainty due to complexity and discretion, raising spreads. ### Country case studies and SCM counterfactual analyses (selected examples) - Botswana: - Medium-term planning and resource-management framework led to large surpluses and net financial savings of 115 percent of GDP in the late 1990s. - Net financial assets fell from about 60 percent in 2008 to below 20 percent by 2011 during GFC; 40 percent expenditure-to-GDP limit proved too loose in good times; proposed rule targets non-mining recurrent primary balance with mineral revenue allocation 60/40 (investment/savings). - Brazil: - Fiscal Responsibility Law (2000) with personnel limits (50/60 percent of net current revenue), subnational debt limits, multi-year primary balance targets, reporting, monitoring and subnational sanctions. - NFPS gross debt fell from 80 percent of GDP in 2002 to 64 percent in 2008; trend reversed since GFC. - Constitutional amendment (2016) caps central government expenditure growth to previous year’s inflation for 20 years; independent fiscal institution created in 2016. - Chile: - Structural balance rule (2001), expert committees for trend output and copper prices, sovereign wealth funds, rule enshrined in law (2006), fiscal council in 2013. - Net assets grew from 3¼ percent of GDP in 2000 to 19½ percent in 2008. - Rule suspended in 2010 after shocks; cumulative debt containment over 2001-11 estimated at close to 15 percent of GDP. - India: - FRBMA (2003) with targets (overall/current deficit targets, debt accumulation limits), procedural rules, and state FRLs; suspension in FY 2008/09 for five years; amendments and pushed deadlines for targets through FY 2018/19. - 2017 Review Committee recommended a medium-term general government debt ceiling of 60 percent of GDP, buoyancy clause, specific escape clause triggers, and an independent fiscal council. - Netherlands, Norway, Sweden, Switzerland: - Netherlands: multiannual expenditure ceilings since 1994, CPB independent forecasts, debt fell to 42 percent of GDP by 2007; limitations in buffer build-up and procyclicality noted. - Norway: oil revenue transfer to GPFG and 4 percent rule (revised to 3 percent in 2017); GPFG assets grew to over 250 percent of mainland GDP by 2015. - Sweden: expenditure ceiling, 1 percent of GDP surplus target (revised to one-third percent from 2019), local balanced budget requirements, independent fiscal council; debt nearly halved to 38 percent by 2012. - Switzerland: “debt brake” (2003) with structural budget balance target, compensation/amortization accounts, corrective measures if compensation account negative beyond 6 percent of expenditures, well-defined escape clause; preserved countercyclicality and helped reduce debt. - Synthetic Control Method (SCM) for counterfactuals: - SCM constructs a weighted synthetic country from controls to match pre-treatment features. - Matching criteria: levels of debt and spending (6, 5, 1 year), age dependency ratio, real GDP per capita, interest-growth differential, output gap, political fractionalization, years left in executive term, share of natural resource exports. - Pros: addresses selection bias, applicable to individual countries, time-varying assessment. - Cons: control pool shrinking due to proliferation of rules; SCM sensitive to idiosyncratic shocks in controls; placebo tests needed; caution in attributing debt decline entirely to rules due to stock-flow adjustments and other factors. ### Conclusions, challenges, and policy-relevant recommendations - Second-generation rules show stronger flexibility, operational clarity, and enforcement features but face challenges balancing simplicity and flexibility. - Design matters: well-designed rules (higher strength index) causally improve fiscal balances; poorly-designed rules do not show robust positive effects. - Calibration matters: - Thresholds often act as de facto targets (magnet effect); set thresholds close to pre-rule averages with buffers to preserve fiscal space and allow countercyclical response. - Compliance and credibility: - Independent fiscal councils, transparent methodologies, and clear escape clauses strengthen monitoring, reputation, and political incentives for compliance. - Serial non-compliance weakens rule effectiveness; serial compliance reinforces it. - Policy guidance: - Adopt a fiscal anchor and a small set of operational rules designed with awareness of interactions across rules. - Prioritize simplicity where possible (growing reliance on expenditure rules signals move toward simpler, enforceable designs). - Use independent institutions and transparent communication to enhance credibility and market confidence. - When introducing numerical targets, consider distributional and state-dependent effects (good times vs bad times) and calibrate thresholds conservatively to allow buffers for downturns. *Source: sdn1804-technical-background-papers (SECOND-GENERATION FISCAL RULES—BACKGROUND PAPERS), International Monetary Fund* ### 1. During the past decade, countries have experienced several large macroeconomic ### During the past decade, countries have experienced several large macroeconomic shocks that put their fiscal rules to the test. ### B. Long-Term Trends in Fiscal Rules — Rule Adoption and Multiplication - Over the past three decades, fiscal rules have spread worldwide with a succession of waves: - First wave: supranational rules surged in advanced economies during the early 1990s related to the 1992 Maastricht Treaty. - Second wave: early 2000s boom of national rules in emerging markets and supranational rules in some low-income countries. - Most recent wave: after the GFC, creation of rules at the national level (mainly in Europe). - Country coverage and composition: - There are currently twice as many emerging market and developing economies than advanced countries with fiscal rules. - Since the 2000s, most new fiscal rule adopters have been low or middle-income economies. - Motivations differ: - Advanced and low-income countries: fiscal requirements of a currency union. - Emerging markets: commit to fiscal adjustment after fiscal crises or lock in gains from reforms (examples: Argentina, Brazil, Colombia, India, Pakistan, Chile, Mexico, Peru, Poland, Russia). - Multiple rules per country have become more common: - The average number of rules has increased steadily over time with acceleration after the GFC. - Europe: average number of rules tripled from 2 to 6 in the past 15 years. - Outside the EU: average number of rules increased from zero to two during the same period. - Many non-European countries had three or more rules by 2015, including 17 countries in Sub Saharan Africa, and also Australia, Grenada, Mongolia and Peru. - Common combinations: budget balance rules and expenditure rules increasingly used with debt rules. - New features introduced to enhance flexibility, monitoring, and enforcement: - Rules adjusted for the economic cycle and with well-defined escape clauses have become more numerous. - Mechanisms to strengthen monitoring and enforcement include formal sanctions, stronger legal basis, and independent fiscal councils. ### B. Long-Term Trends in Fiscal Rules — Rule Resilience - Median rule duration: - Measuring adoption to rescission (or present if not rescinded), the median has been around 9 years. - Re-calibrating an existing rule (changing numerical target or adding characteristics) is not counted as rescission. - Supranational vs national durability: - Supranational rules have been particularly resilient (e.g., European rules established in the 1990s remain). - National rules have a shorter life span and have been more readily scrapped or replaced. - Notable historical features: - European supranational rules from 1992: a 3 percent of GDP ceiling on the overall deficit and a 60 percent of GDP ceiling on gross debt. - 2005: country-specific structural balance rules introduced (Medium Term Objectives, MTO). - 2011: new rule about required speed of debt reduction added; expenditure growth rule introduced as the “expenditure benchmark”. - 2013: many European nations transposed MTOs into national legislation and established correction mechanisms as part of the “Fiscal Compact”. - Shocks that tested resilience: - 2008-10 (GFC): almost a third of the countries with national rules modified them or put them into abeyance. - 2014-2015 collapse in commodity prices prompted many commodity exporters to revise or recalibrate fiscal rules. - Changes to rules: - Changes are defined as modification in the definition of the budget aggregate constrained by the rule (e.g., shift from nominal to structural balance). Pure re-calibrations of targets are not counted. - The number of rule changes increased in recent years as countries modified rule definitions. ### C. The Emergence of a Second Generation of Fiscal Rules — Definition and Characteristics - Definition used in this paper: - Second-generation rules are defined as those introduced in the past decade, generally an evolution of existing rules in the wake of the GFC. - Characterized as being more (i) flexible, (ii) operational, and (iii) enforceable than the first generation. - High-level observation: - Originating in Europe, second-generation fiscal rules have spread worldwide. - These rules seek to address shortcomings of pre-crisis rules and strengthen key features, not to constitute a full paradigm shift. ### C. Second-Generation Feature — More Flexible - Expanded flexibility provisions in two main directions: - Escape clauses for exceptional events: - Pre-GFC escape clauses often did not clearly specify activation circumstances, voting rules, or paths back to the rule. - Post-GFC: escape clauses became more widespread and covered a broader, more specific list of events. - European supranational framework in 2011: introduced a general crisis clause allowing deviations in the event of a severe economic downturn in the euro area or the European Union as a whole. - Examples of well-defined escape clauses outside Europe: Colombia (2011), Jamaica (2014), Grenada (2015). - Provisions for sustainability-improving reforms: - Some second-generation rules allow temporary deviations when countries adopt measures with short-term budgetary cost but long-term fiscal sustainability benefits (e.g., boost to potential growth). - European SGP provisions existed since 2005 (initially for pension reforms); in 2013-15 guidance expanded application to public investment and structural reforms. - Mauritius: 2008 debt rule allows temporary deviations to implement large public investment projects. ### C. Second-Generation Feature — More Operational - Objective: clearer policy guidance targeting fiscal aggregates under policymakers’ control to facilitate implementation and compliance. - Key operational instruments: - Expenditure rules: - Surge in number of expenditure rules and adopters post-GFC. - “Expenditure benchmark” in the European supranational framework (2011): sets a ceiling on annual growth of primary spending. - EU national adopters of expenditure rules include Austria, Croatia, Czech Republic, Greece, Italy, and Spain. - Outside Europe: caps on expenditure growth adopted in Mongolia (2013), Paraguay (2015), and Brazil (2016). - Fiscal effort rules: - Aim to target government “fiscal effort” (discretionary actions taken during a fiscal year). - Common indicator: cyclically-adjusted balance, but it may fail to capture asset and commodity price fluctuations. - Two alternative approaches: - Adjust fiscal balance formula beyond the output gap to correct for revenue windfalls/shortfalls unrelated to the business cycle (used in SGP corrective arm since 2011). Examples: Colombia (2011) and Mongolia (2013) corrected for the commodity price cycle. - Base computation on budget information (budget estimates of tax measures) rather than cyclical adjustments to collected revenue. Examples: “discretionary fiscal effort” indicator (Carnot and De Castro, 2015) and the European “expenditure benchmark”. *Prepared by Andrew Hodge, Young Kim, and Victor Lledó (all Fiscal Affairs Department).* ### 14. Second-generation rules are supported by enhanced monitoring and correction ### 14. Second-generation rules are supported by enhanced monitoring and correction mechanisms ### Monitoring and institutional innovation - Monitoring by fiscal councils: - Prior to the GFC, only Belgium had an independent fiscal council with a mandate to monitor fiscal rules. - Currently, 31 countries have assigned independent fiscal institutions to monitor their fiscal rules, 26 of which are EU members. - In 2015, the European Fiscal Board was established to monitor the implementation of supranational rules. - Outside the EU, Brazil, Chile, Colombia, Peru, and Serbia created independent institutions to monitor fiscal rules over the last five years. - Correction mechanisms: - Many European countries, as part of the 2012 Fiscal Compact, introduced correction mechanisms to specify actions and the path back towards the structural balance rule following a deviation (examples: Denmark, Germany, Estonia in 2012; Hungary, Slovak Republic, Sweden, Slovenia in 2013). - Designs vary widely across countries in degrees of automaticity, specificity, and coercion. - Outside Europe, correction mechanisms are less common but have been introduced in a few countries, such as Jamaica in 2014 and Grenada in 2015. ### Spotlight on correction mechanisms — activation - Purpose: stipulate what policymakers should do if fiscal rules are breached or are at risk of being breached. - Activation dimension — how and when mechanisms are triggered: - Automatic activation vs discretionary action: the term “automatic” refers to triggering of the mechanism (activation), not to the corrective actions (which are most often discretionary). - Actual deviation vs risk of deviation: - Most mechanisms are triggered ex post (after a breach), as under the European Fiscal Compact. - Some frameworks trigger actions ex ante when there is an elevated risk of breach (example: Poland’s mechanism triggered preemptively as debt approaches its ceiling). - Quantitative vs qualitative assessment of deviations: - Precise quantitative triggers: e.g., Slovakia’s mechanism triggers when debt crosses particular thresholds. - Qualitative assessment: e.g., Finland, Ireland, and Italy trigger on “significant deviations” from the Medium-Term Objective (MTO) as assessed according to the European Commission definition; Belgium and France trigger when the national fiscal council assesses a significant deviation. - One-off vs cumulative deviations: - Time-window triggers: Finland, Ireland, and Italy assess “significant deviation” based on fiscal performance in the current year, previous year, or over the previous two years. - Cumulative-deviation triggers: debt brakes in Germany, Jamaica, Grenada, and Switzerland are triggered when cumulative deviations from fiscal balance targets cross critical thresholds. ### Spotlight on correction mechanisms — corrective actions - Types of corrective action required: - Restoring rule compliance vs offsetting deviations: - Some mechanisms require deficit reduction to restore compliance with previous structural balance targets (examples: Belgium, France, Portugal). - Others require “overachieving” targets to offset past deviations so that cumulative deviations do not permanently raise debt (example: German and Swiss “debt brakes”). - Timeframe for correction: - Many mechanisms require corrective action within a specified timeframe, usually over several years: - Belgium, Finland, France: corrective action must be taken within one and a half to two years. - Grenada: required timeframe is three years. - More stringent mechanisms require immediate corrective action or inclusion in the next budget: - Slovakian rule: government must submit a balanced budget to Parliament in the next fiscal year if debt is within three percentage points of GDP of the ceiling. - Policy mix for corrective action: - Some mechanisms leave full discretion over instruments (example: German and Swiss debt brakes allow any combination of revenue and expenditure measures). - Some stipulate policy instruments to be used (example: Slovakian rule mandates an across-the-board expenditure cut, subject to some exceptions, if debt crosses a threshold). ### Conclusions — challenges and frontier issues - Second-generation rules are still in their infancy and face significant challenges: - Achieving flexibility without making rules too complex: - Second-generation rules increase flexibility and operational guidance but often at the expense of simplicity. - Complex rules can produce additional policy errors; the next frontier is designing rules that balance simplicity, flexibility, and enforceability. - The growing reliance on expenditure rules signals a move toward simpler, enforceable designs. - Taking a holistic approach to fiscal frameworks: - Multiple rules added over time can create overlapping or inconsistently calibrated systems. - Policymakers should adopt a fiscal anchor and a small number of operational rules, designing them with awareness of interactions across rules. - Improving compliance: - Widespread introduction of fiscal councils has improved transparency and raised reputational and political costs of breaches. - Further improvement requires better alignment of political incentives with rule compliance. --- ### DO FISCAL RULES IMPROVE THE FISCAL BALANCE? — Key empirical findings and methods ### Main empirical findings - Cross-country averages and raw correlation: - In a comprehensive sample of over 140 countries over the period 1985-2015, fiscal deficits averaged 2.1 percent of GDP in the absence of fiscal rules and 1.7 percent of GDP in the presence of fiscal rules. - Endogeneity and causal inference: - The positive correlation between rules and performance does not imply causation because of endogeneity arising from: - Reverse causality (rules adopted after stress or consolidation episodes). - Omitted variables (countries with rules may have unobserved characteristics fostering prudence). - Measurement errors (misclassification of whether countries have rules). - Using a new instrumental variable (IV) strategy based on adoption of fiscal rules in neighboring countries, the paper finds: - Fiscal rules per se have no statistically significant impact on the fiscal balance once endogeneity is adequately controlled for. - Well-designed rules do have a statistically significant and positive impact on the fiscal balance when rule design is measured and endogeneity is addressed. - Instrumental variable strategy: - Instrument: presence/adoption of fiscal rules in neighboring countries to capture diffusion/peer pressure and provide exogenous variation in domestic rule adoption. ### Data and descriptive statistics - Sample and coverage: - IMF database (IMF, 2017) provides country-specific information on fiscal rules in use in 96 countries from 1985 to 2015. - The panel increases to over 140 countries when adding countries without rules. - Time coverage of the empirical analysis: 1985-2015. - IMF fiscal rules strength index: - The index captures dimensions: broad institutional coverage, independence of monitoring/enforcement bodies, legal base, flexibility to respond to shocks, existence of correction mechanisms and sanctions. - Index values: - Equal to zero for countries without rules. - Ranks from 0.1 (poorly designed) to 1 (well designed) for countries with rules. - Distributional summaries: - The text notes “an average strength index of 0.26 (Table 1)”, suggesting room for improvement. - Table 1 reports: - Obs. 1,296 - Mean 0.294 - Std. Dev. 0.140 - Variance 0.020 - Skewness 1.076 - Percentiles: 1% 0.107; 5% 0.116; 10% 0.132; 25% 0.181; 50% 0.259; 75% 0.375; 90% 0.484; 95% 0.570; 99% 0.738 - Note in the source: “The index is equal to zero for countries without rules and ranks from 0.1 (poorly designed) to 1 (well designed) for countries with rules.” - Countries with values of the index above 0.8 include Lithuania, Latvia, Great Britain, the Netherlands and Romania. - Regional timing: - Number of fiscal rules increased significantly over time, starting in the early 1990s in Europe and the late 1990s for the Western hemisphere and Africa. ### Baseline empirical specification and controls - The baseline model augments a standard fiscal reaction function and includes: - Dependent variable: budget balance (balance). - Key regressor: fiscal rule indicator (rule), a dummy equal to 1 if a country has any type of fiscal rule in place. - Controls: - Lags of the government balance to control for persistence. - Lagged debt to control for the relation between balance and debt. - GDP per capita (loggdp) to control for level of development. - GDP growth (gdpgrowth) to capture economic growth. - Output gap (ogap) to capture the business cycle. - Terms of trade movements (Δtot) (important for commodity exporters and low-income countries). - Dummies for currency unions (cunion) and IMF programs (imf). - Country fixed effects (αi) and year fixed effects (λt). - Purpose of specification: - To identify the effect of the presence of a fiscal rule (and the role of rule design) on fiscal balance while addressing persistence, macroeconomic conditions, institutional settings, and endogeneity. *Prepared by Francesca Caselli (Research Department) and Julien Reynaud (Fiscal Affairs Department), based on Caselli and Reynaud (forthcoming).* ### 9. Our instrumental variable strategy relies on the diffusion of fiscal rule adoption in ### 9. Our instrumental variable strategy relies on the diffusion of fiscal rule adoption in neighboring countries ### Instrumental variable strategy and intuition - Instrument: the number of neighboring countries adopting a fiscal rule in the previous year. - Intuition: fiscal reforms in neighboring countries may affect domestic adoption through peer pressure and imitational effects (Buera et al., 2011; Giuliano et al. 2013). - Identification assumption: fiscal rule adoption in neighboring countries impacts the domestic fiscal balance only through the adoption of a domestic fiscal rule (potential violation if neighbors’ rules generate direct fiscal spillovers). - Comparable approaches: spatial diffusion instruments used in growth, economic integration, and trade literatures (e.g., Frankel and Romer,1999; Frankel and Rose, 2002; Acemoglu and others, 2016). ### Diffusion of fiscal rules: regional patterns - Empirical pattern: diffusion follows regional waves; early adopters in the 1980s included few countries in South East Asia, the United States and Germany. - Subsequent spread: early 1990s — Europe; late 1990s — South America and Africa; 2000s — Eastern Europe and Central Asia. - Source: Staff's calculation based on IMF Fiscal Rules database. ### OLS results (correlation evidence) - Overall OLS finding: overall balances are higher by 0.8 percent of GDP in countries with fiscal rules, on average (Table 2 Column 1). - Pre-global financial crisis correlation: 0.83 percent of GDP (Table 2 Column 2). - By country group: - Advanced Economies (AEs): 0.83 percent of GDP (Column 3). - Emerging Markets (EMs): 0.08 percent of GDP (Column 4, no correlation). - Low Income Countries (LICs): 1.16 percent of GDP (Column 5, highest correlation). - Selected control coefficients (Table 2): - L1 Balance: 0.45*** (full sample Column 1) with (0.04) standard error. - GDP growth: 0.12*** (full sample Column 1) with (0.02) standard error. - Delta ToT: 0.04*** (full sample Column 1) with (0.01) standard error. - IMF program (full sample Column 1): 0.29 (0.18). - Sample sizes and fit: - Observations: 2,823 (full sample Column 1). - R-squared: 0.71 (full sample). - Note: Standard errors clustered at the country level. *** p<0.01, ** p<0.05, * p<0.1. ### Common IVs in the literature and their limitations - Typical instruments: government fragmentation, checks and balance, adoption of inflation targeting, lag of the fiscal rule, commitment approach to centralize budget process. - Performance in a global sample: - Relevance: government fragmentation, checks and balance and inflation targeting are weak instruments (first stage Kleinbergen-Paap F-stat well below Staiger and Stock (1997) rule-of-thumb value of 10; Table 3 Columns 1–4). - Exogeneity concerns: these instruments may directly affect fiscal balances: - Government fragmentation can affect fiscal outcomes through coordination problems (Kontopoulos and Perotti, 2002). - Checks and balance can impede fiscal discipline by protecting minority rights and delaying tough adjustments (Alesina and Perotti, 1996). - Inflation targeting can mitigate fiscal dominance and directly affect fiscal balances (Combes and others, 2017). - Diagnostic statistics (Table 3 for IVs): - Kleinbergen-Paap rk test values: 7.65 (Inflation Targeting), 0.51 (Government Fragmentation), 0.65 (Checks and Balance), 2.07 (All IV together). - Stock-Wright p-values: 0.01, 0.48, 0.42, 0.11 respectively. - Conclusion: common IVs perform poorly for the global sample. ### Novel IV approach: diffusion-based instruments and IV results - Novel instruments: diffusion of fiscal rules (number of neighboring adopting a fiscal rule) and diffusion of fiscal rule strength (average fiscal rule strength in neighboring countries). - IV estimation results (Table 4): - Column (1): Fiscal Rule Dummy coefficient = 1.376 with (0.872) standard error; IV = Diffusion of fiscal rules. - Column (2): Fiscal Rule Strength Index coefficient = 3.378** with (1.671) standard error; IV = Diffusion of fiscal rule strength index. - Observations: 2,797 (Column 1); 2,526 (Column 2). - R-squared: 0.302 (Column 1); 0.298 (Column 2). - Number of id: 142 (Column 1); 130 (Column 2). - Kleinbergen-Paap rk test: 11.23 (Column 1); 43.70 (Column 2). - Stock-Wright p-value: 0.00 (both columns). - Interpretation: - When controlling for endogeneity with diffusion IV, the fiscal rule adoption dummy loses statistical significance but magnitude comparable to OLS. - The strength-index IV shows a positive and statistically significant relation with fiscal balance. - Instrument strength diagnostics: - Kleinbergen-Paap F-stat of 11.23 (Column 1) is above Staiger and Stock (1997) threshold of 10. - First stage shows a positive and significant coefficient at the 90 percent level, suggesting IV relevance. - Additional weak-instrument tests confirm the new instruments are not weak. ### Rule design, strength, and heterogeneity of effects - Fiscal rule strength index: constructed so that 0 = no-rule; positive number describes quality of design; 1 denotes the strongest rule. - Magnitude interpretation: - Coefficient on strength index = 3.378 (Table 4 Column 2). - Moving from the 25th to the 75th percentile of the strength index (actual change = 0.19) results in an improvement of the budget balance by 0.64 percent of GDP (calculation: 3.4 * 0.19 as described). - Poorly-designed vs better-designed rules (OLS results, Table 5): - Poorly designed rules (first quartile of index) coefficient = 0.40 (0.46) — not statistically significant (Column 1). - Better designed rules (above first quartile) coefficient = 0.77*** (0.26) — statistically significant (Column 2). - Observations: 1,935 (Column 1); 2,580 (Column 2). - R-squared: 0.77 (Column 1); 0.71 (Column 2). - Caveats and limitations: - IV application is weak for sub-samples; regressions comparing poorly vs better-designed rules are estimated without IV. - Definition of poorly-designed rules uses an ad-hoc threshold at the first quartile. - The strength index focuses on design, not implementation or political/public support. ### Conclusions (policy-relevant findings) - Average causal effect: - Main finding: fiscal rules per se do not have a statistically significant impact on the fiscal balance once endogeneity is adequately controlled for using diffusion-based IVs (sample: over 140 countries, period 1985-2015). - This insignificance aligns with findings of Heinemann and others (2018). - Role of design: - Design features matter: better designed rules have a strong and significant positive impact on the fiscal balance. - Poorly-designed fiscal rules do not show a statistically significant deterioration of the fiscal balance, but this result is subject to important caveats (measurement, IV weakness in sub-samples, arbitrary thresholds). *Source: SECOND-GENERATION FISCAL RULES—BACKGROUND PAPERS, International Monetary Fund* ### 1. Empirical studies on the effectiveness of fiscal rules have mostly focused on the ### Empirical studies on the effectiveness of fiscal rules have mostly focused on the ### Overview - Empirical literature has primarily estimated “average effects” of fiscal rules (FR) on government fiscal balances across countries (references include Bergman and others 2016; Heinemann, Moessinger, and Yeter 2018; Tapsoba 2012; Debrun and others 2008; Caselli and Reynaud 2018). - This paper extends the literature by estimating the impact of a numerical FR (the 3 percent general government deficit ceiling) on the entire distribution of government deficits among European countries, not only on the mean. ### Sample and focus - Sample: 33 EU member and candidate countries from 1970 to 2016. - Focus: the 3 percent general government deficit ceiling in EU countries; advantage is a common numerical rule and staggered adoption dates across countries. ### Research questions and motivation - Does the introduction of a numerical FR affect only the average fiscal outcome or also the dispersion/distribution of deficits across countries? - Could a rule act as a “pulling force” or “magnet effect,” causing deficits/balances to bunch around the rule’s threshold (3 percent deficit ceiling)? - How to recover causal impacts given selection into FR adoption? ### Estimation methodology - Four-step empirical approach: 1. Model adoption of the FR and correct for selection bias using a first-stage logit model to estimate propensity scores. 2. Construct a counterfactual group via the efficient inverse probability weighting (IPW) procedure of Hirano, Imbens, and Ridder (2003). 3. Recover the average treatment effect by comparing means of treated and counterfactual groups. 4. Estimate the causal impact of the deficit rule on the entire distribution of fiscal outcomes by comparing empirical density functions for treated and counterfactual samples and, under further assumptions, recover counterfactual observations for individual countries. - Relation to literature: builds on heterogeneous and distributional effects methods (e.g., Chamberlain 1994; Stock 1989; Heckman and Vytlacil 2007; Koenker 2017) and on quantile/distribution regressions and reweighting approaches (e.g., DiNardo, Fortin, and Lemieux 1996; Firpo 2007; Donald and Hsu 2014). ### Correcting for self-selection into fiscal-rule adoption - Two-step correction: - First-stage logit model accounts for relevant observed characteristics predicting FR adoption. - Second, generate counterfactual by weighting control observations with higher propensity scores more heavily to match treated-group characteristics. - Exact definition of weights provided in the source: - The weights are defined as follows: 푤̂ 푐푡 =1 { 퐹푅 푐푡 =1 } /푃 ̂ −1 { 퐹푅 푐푡 =0 } 푃 ̂ 푐푡 푃 ̂ (1−푃 ̂ 푐푡 )⁄ where 푃 ̂ and 푃 ̂ 푐푡 are the unconditional and conditional probabilities, respectively, of fiscal rule adoption. 푃 ̂ is the share of observation that adopted a fiscal rule in our sample and 푃 ̂ 푐푡 is obtained from a logit model. - Identification assumption: selection on observables (after conditioning on covariates, adoption is as good as random). ### Predictors (covariates) used in the selection equation - Four categories of predictors: - Fiscal variables (e.g., past fiscal behavior, lags of balance, lag 1 debt, age dependency ratio). - Macroeconomic variables (e.g., log GDP per capita, GDP per capita growth, inflation). - Institutional factors (e.g., political stability, government fragmentation, federal structure). - Economic and monetary integration criteria (e.g., trade relationship with EU-11, price/output co-movement) to isolate selection into the 3 percent rule from Euro area accession effects. ### First-stage (logit) results and diagnostics - Variables with strongest predictive power for FR adoption: age dependency ratio, log of GDP per capita, lags of the balance (particularly lag 2 and lag 3), and trade relationship with EU-11. - Interpretation highlights: - High age dependency ratios increase the desire to adopt FR to address spending pressures. - Past deficits (second and third lags) are related to adoption. - Higher GDP per capita is associated with higher probability of adoption. - Trade variable shows a negative coefficient in multivariate models due to collinearity; univariate coefficient positive and significant. - Model diagnostics: - Bayesian Information Criteria (BIC) indicates model (2) achieves the best balance between predictive power and “overfitting.” - Tests for covariate balance (Imai and Ratkovic (2014)) do not reject balance for all four models, supporting the appropriateness of counterfactuals. - Selected first-stage marginal effect estimates (Table 1 highlights; coefficients multiplied by 100; standard errors clustered at country level): - Lag 1 balance: 0.100 (model 1), 0.067 (2), 0.251 (3), 0.137 (4). - Lag 2 balance: -0.821 (1), -1.020* (2), -1.213** (3), -1.094* (4). - Lag 3 balance: 0.667 (1), 0.877* (2), 0.924* (3), 0.810* (4). - Lag 1 debt: 0.036 (1), 0.063* (2), 0.072* (3), 0.065* (4). - Age dependency ratio: -0.775*** (1), -0.561** (2), -0.537* (3), -0.667** (4). - Log GDP per capita: 8.924*** (model 2 reported), 8.890** (model 3 reported), 14.377*** (model 4 reported). - Trade with EU-11 (model 4): -0.163* (0.071). - Pseudo R-squared: 0.103 (1), 0.212 (2), 0.224 (3), 0.501 (4). - BIC: 226.0 (1), 222.0 (2), 227.7 (3), 233.5 (4). - Observations: 552 (models 1 and 2), 492 (3), 541 (4). - Note: * means p<10%, ** p<5%, *** p<1%. ### Main results on fiscal balances — average effects - Average treatment effect on the treated (ATET) estimates (Table 2): - Diff-in-diff 1 ATET: 1.17**; Std. error 0.66; P-value 0.09; Min95 -0.18; Max95 2.51; Obs. 1156. - Diff-in-diff 2 ATET: 2.29***; Std. error 0.78; P-value 0.01; Min95 0.71; Max95 3.88; Obs. 1156. - IPW 1 ATET: 0.99; Std. error 0.64; P-value 0.12; Min95 -0.26; Max95 2.25; Obs. 1019. - IPW 2 ATET: 0.56; Std. error 0.71; P-value 0.43; Min95 -0.83; Max95 1.96; Obs. 1007. - IPW 3 ATET: 0.07; Std. error 0.64; P-value 0.91; Min95 -1.20; Max95 1.34; Obs. 905. - IPW 4 ATET: 0.42; Std. error 0.66; P-value 0.52; Min95 -0.88; Max95 1.72; Obs. 843. - Interpretation: - Difference-in-differences specifications without correction for selection show large and statistically significant coefficients. - Once controlling for selection into FR adoption using IPW, coefficients become smaller and statistically insignificant across specifications. - Conclusion: the introduction of the FR does not have a significant effect on the government balance average after correcting for selection — consistent with prior evidence (Heinemann, Moessinger, and Yeter, 2017). ### Main results on fiscal balances — distributional effects - Key distributional finding: - The introduction of the 3 percent general government deficit ceiling narrowed the entire distribution of government balances across countries. - The deficit rule led high-deficit countries to reduce deficits, while countries with low deficits (high balances) reduced their government balance — evidence of a “magnet effect” drawing observations toward the 3 percent ceiling. - Bunching statistic: - 20 percent of the sample “bunches” in the region around the 3 percent deficit ceiling in the treated group compared to the counterfactual group. - Country-level impacts: - Most European countries saw their fiscal position improve as a result of the deficit rule; they would have recorded higher deficits in the absence of the rule. - Positive effect observed for 22 countries out of the 28 countries that adopted the 3 percent deficit rule in the sample. - Across these countries, government balances improved by 0.7 percent of GDP on average as a result of the rule. - Implication: - Provides new evidence of the effectiveness of fiscal rules even when governments do not strictly comply with the numerical limit. ### Additional notes on identification and limitations - Causal interpretation relies on selection on observables; unobserved confounders correlated with both adoption and outcomes would violate identification. - Since adoption of the 3 percent FR coincided with Euro area integration for many countries, the effect of the 3 percent rule cannot be fully separated from broader effects of EU membership in some cases. - The approach produces both average and full-distributional causal estimates and enables recovery of counterfactual observations for individual countries under further assumptions. *Source: sdn1804-technical-background-papers (PDF chapter/section); canonical URL: https://www.imf.org/-/media/files/publications/sdn/2018/sdn1804-technical-background-papers.pdf* ### 12. The introduction of the 3 percent deficit ceiling changed the entire shape of the deficit ### 12. The introduction of the 3 percent deficit ceiling changed the entire shape of the deficit ### Distributional effects of the 3 percent deficit ceiling - Method: Kernel density estimates for treated (with FR) and counterfactual groups, correcting for selection bias; vertical dashed and solid lines mark the 10th percentiles, means and 90th percentiles of the respective distributions. - Average effect: - The average effect of the FR on the balance is positive (middle blue solid line to the right of the middle dashed red line) but not statistically significant when properly correcting for selection bias. - Distributional pattern: - Large, opposite-signed effects at the tails of the deficit distribution: - The 3 percent deficit ceiling reduced the deficit among high-deficit countries (left-hand side of the distribution). - The ceiling increased deficits (reduced balances) among low-deficit / high-balance countries (right-hand side of the distribution). - Net effect: observations are pulled towards the middle of the distribution. - Interpretation: - Standard average treatment effect estimates capture the “average” country but fail to describe the full extent of the FR’s impact across all countries. - Average estimates overstate the impact on high-balance countries and underestimate the impact on countries with large deficits. - The FR affected non-compliers even when deficit levels remained above the ceiling in many cases. _Source: Caselli and Wingender (2018)._ ### Magnet (bunching) effect around the threshold - Figure 2 analysis: - Plots vertical difference in densities (treatment minus counterfactual) with 95 percent point-wise confidence bands. - Grey area indicates the range where the density of the treatment group strictly exceeds the counterfactual density (bunching). - Bunching range: - Starts slightly below the deficit ceiling of -3 percent and extends from -4.2 percent of GDP to 2.8 percent of GDP. - Magnitude: - 20 percent of the treatment group is “closer” to the threshold than in the counterfactual group (share in excess of counterfactual within the deficit range). - Of the 20 percent excess density, 15 percent is located above the -3 percent ceiling, in compliance with the FR. - Policy-relevant implication: - Asymmetric bunching is consistent with the “close-to-balance” requirement of the original Stability and Growth Pact (medium-term objective to achieve a fiscal position close to balance or in surplus). ### Country-specific counterfactuals and rank invariance assumption - Identification assumption: - Rank invariance: ordering of country-year observations in the treatment group remains the same in the counterfactual group (the FR can affect dispersion but not relative positions). - Rationale: fiscal behavior is persistent and slow moving due to operational and political constraints and stability of national preferences. - Examples under rank invariance: - Italy in 1996: - Observed: 10th percentile, deficit of 6.75 percent of GDP. - Counterfactual (no rule) assumed 10th percentile deficit: 7.8 percent of GDP. - Finland in 2000: - Observed: largest balance, surplus of 6.9 percent of GDP. - Counterfactual top ranking balance: 7.1 percent of GDP. - Note on strength of assumption: - Rank invariance is strong but arguably plausible for fiscal variables; country fixed effects explain 47 and 40 percent of total rank variance in control and treatment groups respectively. ### Aggregate country results and heterogeneity - Sample and headline counts: - Sample: 28 countries that adopted the 3 percent deficit rule. - 22 countries (about three quarter of the sample) saw an improvement on their average annual deficit level. - 6 remaining countries: Luxembourg, Estonia, Sweden, Ireland, Finland and Denmark. - Magnitudes: - Across the 22 improved countries, government balances improved by 0.7 percent of GDP on average. - For the 6 remaining countries, government balances decreased by 0.5 percent of GDP on average (these are among the highest average government balances in the sample). - France: average effect of the FR was a 0.95 percent of GDP improvement in the government balance. - Time-path heterogeneity: - Germany: FR effect on the balance was almost always positive through the 1990s and 2000s, becoming negative starting in 2012 when Germany began running surpluses. - France: would have had consistently larger general government deficits without the FR. ### Conclusions and policy implications - Main conclusions: - The impact of fiscal rules extends beyond average effects and materially affects the distribution of fiscal balances. - The average treatment effect of the 3 percent deficit rule is small and statistically insignificant, but this masks substantial heterogeneity—large effects at the bottom of the distribution for the largest deficit countries. - Most EU countries have seen their fiscal deficits decrease as a result of the FR. - Magnet effect and compliance: - FRs exert a magnet effect, pulling fiscal outcomes toward thresholds and producing opposite impacts for strong and weak performers. - FRs are effective in constraining fiscal policies in non-compliers (large-deficit countries), while compliers (stronger performers) tend to reduce government balance and converge toward the -3 percent ceiling. - Temporal and state-dependent effects: - The effect of the 3 percent deficit ceiling on individual countries has varied over time and with the level of deficits: - In good times (high balances), the rule tended to reduce balances. - In bad times (large deficits), the rule reduced deficits. - Policy recommendation: - Policymakers should carefully consider the costs and benefits of introducing numerical targets because impacts can be complex and interact with a country’s current fiscal position in unexpected ways. - Additional implication: - Rules can affect deficits even when not fully complied with; deficits among EU countries that did not comply with the -3 percent deficit ceiling would have been even larger absent the FR. *Source: Caselli and Wingender (2018).* ### 4. This paper tries to close the gap through an empirical assessment of how ### 4. This paper tries to close the gap through an empirical assessment of how ### Objectives and extensions - Assess how (non)compliance with budget balance rules (BBRs) affects fiscal behaviors across all types of budget balance rules. - Replicate and extend Reuter (2015) by: - Using a broader country sample covering European national rules and national and supranational rules in other advanced economies, emerging markets, and developing countries. - Assessing how compliance dynamics change depending on the size and recurrence of past deviations, and on the strength of a fiscal rule. ### Six main empirical results - Threshold-reversion effect: - Both positive and negative deviations between fiscal deficits and rule thresholds disappear over time; budget balances constrained by rules are pulled towards the rules’ thresholds. - Asymmetry in convergence: - The threshold-reversion effect is stronger for negative than for positive deviations (convergence to the threshold is faster for countries currently not complying than for countries in compliance). - Role of size and recurrence: - The intensity of the threshold-reversion effect depends on the size and recurrence of deviations: stronger for large infrequent negative deviations; weaker for small recurrent deviations. - Rule design and complementarities: - Budget balance rules with better design features or supported by other types of rules (debt or expenditure rules) do not generally exert a stronger pulling force. - Stationarity of budget balances: - Budget balances are found to be stationary in most countries and converge to their long-term mean, regardless of whether countries have a BBR. - Threshold calibration: - BBR thresholds are generally set close to the average of the fiscal balance prior to rule introduction. - Mean-reversion comparisons (countries with vs without rules): - For negative deviations: countries with rules tend to have a faster mean-reversion than countries without rules; mean-reversion is even faster if the rule’s threshold is set close to the pre-rule balance average. - For positive deviations: countries with rules tend to display a slower mean-reversion than countries without rules; mean-reversion is even slower if the rule’s threshold is near the fiscal balance average prior to rule adoption. ### Main policy implications (three headline messages) - Rules need not be strictly complied with to influence deficits: - Rules influence deficits even if not complied with, provided deviations are not too recurrent; rules can attract deficits towards thresholds after large infrequent deviations. - Effectiveness in reducing deficit biases: - By ensuring above-average fiscal deficits are more quickly eliminated and below-average deficits preserved longer, countries with BBRs may be more effective in reducing excessive deficit biases than countries without such rules. - Importance of threshold calibration: - The pulling effect of the rule’s threshold reinforces the importance of calibrating rules adequately; proper calibration of the rule threshold tends to matter more than other design features when ensuring rule deviations are quickly eliminated. - Countries tend to treat rules’ thresholds as implicit targets rather than ceilings; calibration should take this behavior into account and err on the side of caution. ### Data, measurement, and sample - Dataset coverage: - 55 national and 6 supranational budget balance rules (BBRs) in force among 49 countries between 1985 and 2016. - Types of BBRs examined: - Overall (nominal), primary (excludes interest rates), operational (excludes capital spending), structural (adjusts for business and commodity cycles and excludes one-off spending), and non-oil (excludes oil revenues). - Sources: - IMF fiscal rule dataset (Lledó and others, 2017) for BBR types and thresholds; IMF’s Government Finance Statistics and World Economic Outlook for budget balance outturns. - Definition of economic compliance: - dev_{i,j,t} = var_{i,j,t} − thrsd_{i,j,t} (in percent of GDP). Negative value = outturn below threshold = noncompliance. Zero or positive = compliance. - Rationale for focusing on BBRs only: - Worldwide presence maximizes sample; compliance analysis less relevant for other rules (e.g., debt rules) that are less expected to bind short-term policies; focusing on BBRs avoids scaling issues when combining different rule types. ### Descriptive statistics and stylized facts - Global compliance frequency: - Rule compliance is close to 50 percent at the global level: across all rules, countries and years, BBR deviations from thresholds are on average positive half of the time. - Summary statistics (Table 1): - Total — Frequency of positive deviations: 50.4; Median: 58.3; Std Dev: 2.6; No Obs.: 1,109 — Magnitude of deviations (percent of GDP): Mean: -0.8; Median: 0.1; Std Dev: 8.4; No Obs.: 1,126. - National rules — Frequency: 54.3; Median: 62.5; Std Dev: 7.5; No Obs.: 340 — Magnitude: Mean: 0.9; Median: 0.8; Std Dev: 4.2; No Obs.: 319. - Supranational rules: non-EU — Frequency: 23.1; Median: 9.8; Std Dev: 29.9; No Obs.: 20 — Magnitude: Mean: -7.1; Median: -2.3; Std Dev: 17.5; No Obs.: 188. - Supranational rules: EU — Frequency: 58.0; Median: 60.0; Std Dev: 24.7; No Obs.: 50 — Magnitude: Mean: 0.2; Median: 0.3; Std Dev: 3.3; No Obs.: 619. - Exclusions: - Supranational rules among non-EU countries (CEMAC and WAEMU) are breached more frequently and by larger margins and are excluded from the econometric analysis due to being outliers and data limitations. ### Persistence and transition probabilities - Deviations are persistent but not permanent: - Conditional transition probability matrix (Table 2) shows higher probability that a deviation of a given size in t−1 will be of similar size in t than of a different size. - Example: Prob(dev_t < −5 | dev_{t−1} < −5) = 68 percent. - Example: Prob(−5 < dev_t < −2 | dev_{t−1} < −5) = 19 percent. - Positive deviations are more likely to move closer to zero than to increase: e.g., probability that a positive deviation in 2–5 percent of GDP range moves to 0–2 percent of GDP is 23 percent; probability it increases above 5 percent is 9 percent; probability it turns into a negative deviation >5 percent is 0 percent. - Interpretation: - While deviations are persistent, they are more likely to disappear (move to zero) in any given year than to increase further—an indication of convergence towards thresholds. ### Rules’ thresholds relative to pre-rule means - Stationarity and proximity: - Budget deficits are found to be stationary for most countries and periods; they converge to long-term averages. - About two-thirds of BBR thresholds in the sample are set within one standard deviation of the average of the fiscal balances constrained by the BBR prior to its introduction. - Table 3 excerpts (medians and means): - All: Median pre-rule adoption mean: -2.4; Median threshold after rule adoption: -3.0; Mean pre-rule adoption mean: -2.5; Mean threshold after rule adoption: -2.3. - National rules: Median pre-rule mean: -2.0; Median threshold: -0.3; Mean pre-rule mean: -2.8; Mean threshold: -1.0. - Supranational rules: EU: Median pre-rule mean: -2.6; Median threshold: -3.0; Mean pre-rule mean: -2.5; Mean threshold: -2.7. - Supranational rules: non-EU: Median pre-rule mean: -0.8; Median threshold: -3.0; Mean pre-rule mean: -1.7; Mean threshold: -3.0. - Budget balance (National): Median pre-rule mean: -3.6; Median threshold: -0.5; Mean pre-rule mean: -3.2; Mean threshold: -1.1. - Primary balance (National): Median pre-rule mean: 0.0; Median threshold: 0.0; Mean pre-rule mean: 0.0; Mean threshold: 0.0. - Budget balance (Supranational non-EU): Median pre-rule mean: -0.8; Median threshold: -3.0; Mean pre-rule mean: -1.7; Mean threshold: -3.0. - Budget balance (Supranational EU): Median pre-rule mean: -2.9; Median threshold: -3.0; Mean pre-rule mean: -2.8; Mean threshold: -3.0. - Structural balance (Supranational EU): Median pre-rule mean: -2.4; Median threshold: -1.9; Mean pre-rule mean: -2.0; Mean threshold: -2.1. - Note on computation: - The pre-rule adoption mean is cyclically adjusted (output gap set to zero) and accounts for persistence of the constrained fiscal balance. ### Econometric framework - Two-stage Heckman selection model to address sample selection bias: - First stage: Probit for the likelihood of having a BBR of type j in country i at time t: P(f_{i,j,t}=1 | X) = Φ(Xγ). Sample: an unbalanced panel of 99 countries from 1991 to 2016. Vector X includes government fragmentation, political regime, government stability, inflation-targeting regime, and currency union membership. - Second stage: Observed deviation dev_{i,j,t} regressed on lagged deviation, controls Z, and latent factors u_{i,j,t}: dev_{i,j,t} = β dev_{i,j,t−1} + Z'_{i,t} δ + u_{i,j,t}. Controls Z include debt ratio, output gap, forecast errors of growth and government revenues, government fragmentation, government stability, election year dummy, and country fixed effects. ### Fiscal Rules as a Magnet: Threshold-reversion effect (estimation results) - Baseline persistence: - Lagged Deviation coefficient ≈ 0.72*** (standard error 0.07) — about 0.7 percentage points of a 1 percentage point previous deviation remain the following period. - Interpretation: deviations are persistent but converge toward the threshold; smaller coefficients imply stronger threshold-reversion and faster convergence. - Asymmetry by sign (Table 4, column specifications): - Lagged Deviation (Positive): coefficients reported as 0.91*** (0.06), 0.88*** (0.12), 0.83*** (0.09), 0.80*** (0.06) across specifications. - Lagged Deviation (Negative): coefficients reported as 0.61*** (0.11), 0.82*** (0.12), 0.76*** (0.09), 0.34*** (0.11) across specifications. - Squared terms: Lagged Deviation (Positive) Squared: -0.016 (0.002). Lagged Deviation (Negative) Squared: -0.017*** (0.003). - Interactions and quantile indicators reported: e.g., Lagged Deviation (Negative) x Deviation < p(25): -0.39** (0.18); Lagged Deviation (Positive) x Above Threshold < 75%: -0.20* (0.11); Lagged Deviation (Negative) x Above Threshold < 75%: 0.26* (0.15). - Sample sizes for estimates in Table 4: - N (1st stage) = 2,436 across specifications. - N (2nd stage) = 761 across specifications. - Implication: - The magnet effect is statistically significant for both positive and negative lagged deviations; estimated coefficients for negative deviations are generally smaller (stronger reversion) than for positive ones, indicating faster convergence among noncompliers. ### Interpretation and additional implications - Rules can affect fiscal deficits even when not strictly complied with: - Deviations do not necessarily accumulate into unsustainable fiscal policies; they can be “self-correcting.” - Fiscal rules, even if not perfectly enforced, can provide a benchmark that is easily monitored and punishable by voters and markets, helping prevent gross policy errors. - Complementary evidence: - Background papers 2 and 6 indicate the effect of fiscal rules can be stronger if rules are well-designed, well-calibrated, and strictly complied with. *Source: IMF—SECOND-GENERATION FISCAL RULES—BACKGROUND PAPERS (section summarizing empirical assessment of compliance dynamics with budget balance rules).* ### 18. There are reasons to believe that the threshold-reversion effect depends on the size of ### 18. There are reasons to believe that the threshold-reversion effect depends on the size of ### Size dependence of the threshold-reversion effect - Theoretical ambiguity: large negative deviations may trigger corrective actions, whereas large deviations might also undermine credibility and adherence. - Empirical findings: - Adding a quadratic term for the lagged deviation shows that the speed of convergence increases with the size of the deviation, but only for negative deviations (Table 4, column 3). - Negative deviations below the 25th percentile of the empirical distribution show a stronger and statistically significant threshold-reversion effect than less negative deviations (Table 4, column 4). - No statistically significant evidence that large positive deviations show a stronger threshold-reversion effect: the interaction term between positive deviations and whether they are among the top 75th percentile is not statistically different from zero. ### Frequency of deviations and serial compliance - Hypotheses tested: - More frequent negative deviations reduce credibility of the rule threshold and weaken the threshold-effect (likely when deviations are small and easily accommodated). - More frequent compliance reassures public and markets and reduces buffers demanded, strengthening the threshold-effect. - Empirical result: - The threshold-reversion effect is weaker among serial non-compliers, but stronger among serial compliers (Table 4, column 5). ### Design of fiscal rules - Reforms aimed at enforcement: independent monitoring bodies, enshrinement in high-order legislation, formal sanctions, pre-established correction mechanisms; overall framework improvements via formal fiscal anchors and multiple operational rules. - Empirical findings on rule design: - Neither the strength nor the combination of fiscal rules significantly affect how fast deviations are closed either from above or below (Table 5, columns 1 and 2). - Convergence of noncompliers is faster for rules where the threshold is within one standard deviation of the fiscal balance average prior to adoption (Table 5, column 3). - Selected estimation coefficients from Table 5 (for model columns reported): - Lagged Deviation (Positive): 1.10*** (0.20); 0.91*** (0.06); 0.98*** (0.09) - Lagged Deviation (Negative): 0.47*** (0.30); 0.62*** (0.11); 0.69*** (0.16) - Lagged Deviation (Positive) X IMF Strength Index: -0.07 (0.08) - Lagged Deviation (Negative) X IMF Strength Index: 0.05 (0.12) - Lagged Deviation (Positive) X (Debt Rule and Expenditure Rule): -0.08 (0.11) - Lagged Deviation (Negative) X (Debt Rule and Expenditure Rule): -0.28 (0.23) - Lagged Deviation (Positive) X Threshold set within 1 S.D. of pre-rule adoption mean: -0.08 (0.12) - Lagged Deviation (Negative) X Threshold set within 1 S.D. of pre-rule adoption mean: -0.28* (0.17) - Controls: Yes; Country fixed effects: Yes - N (1st stage): 2,436; N (2nd stage): 761 (columns vary; see table) ### Country groups and time periods - Country group heterogeneity: - Currency unions: threshold-reversion effects are not distinguishable from others (Table 6, column 1). - Advanced economies: compliers and noncompliers can deviate longer given larger tax bases and more stable financing (Table 6, column 2). - Time-period heterogeneity (pre/post GFC): - No discernible average effect for negative deviations before and after the global financial crisis (GFC). - Compliers show a more accelerated pace of convergence to the rule-threshold in the post-GFC period for positive deviations (Table 6, column 3). - Selected estimation coefficients from Table 6 (for model columns reported): - Lagged Deviation (Positive): 0.84*** (0.08); 0.63*** (0.18); 0.96*** (0.07) - Lagged Deviation (Negative): 0.61*** (0.09); 0.27*** (0.16); 0.55*** (0.10) - Lagged Deviation (Positive) X Currency Union: 0.11 (0.10) - Lagged Deviation (Negative) X Currency Union: -0.00 (0.15) - Lagged Deviation (Positive) X Advanced Economies: 0.30* (0.18) - Lagged Deviation (Negative) X Advanced Economies: 0.37* (0.19) - Lagged Deviation (Positive) X 2007-16: -0.26* (0.11) - Lagged Deviation (Negative) X 2007-16: 0.06 (0.15) - Controls: Yes; Country fixed effects: Yes - N (1st stage): 2,436; N (2nd stage): 761 ### Dynamics with and without rules (mean-reversion analysis) - Strategy: - Compare mean-reversion of budget balances in countries/years with rules in force to those without, using deviations from long-term averages computed over the entire period. - Estimate model (2’): devm_{i,t} = β devm_{i,t−1} + θ devm_{i,t−1} I_{i,t} + Z′_{i,t} δ + u_{i,t}, where I_{i,t} = 1 if at least one BBR is in force. - Restricted sample: countries that adopted rules at some point between 1991 and 2016; robustness checks include broader sample of 57 countries. - Main findings (Table 7 and related text): - Budget balances revert to long-term averages regardless of rules. - In countries/years without rules, mean-reversion is faster (smaller regression coefficients) for positive than for negative deviations: above-average deficit episodes are more persistent → “deficit bias”. - Adoption of rules slows mean-reversion for positive deviations (making above-average deficits less persistent than below-average ones when combined with other effects). - Adoption of rules accelerates mean-reversion for negative deviations, especially when thresholds are set close to the long-term average. - Net effect: rule adoption leads mean-reversion to be slower for positive than for negative deviations, helping reduce the deficit bias observed in countries without rules. - Selected estimation coefficients from Table 7 (columns reported): - Dependent Variable: Deviations from Mean - Lagged Deviation (Positive): 0.51*** (0.11); 0.58*** (0.16); 0.70*** (0.08); 0.73*** (0.07) - Lagged Deviation (Negative): 0.91*** (0.07); 0.75*** (0.09); 0.75*** (0.09); 0.75*** (0.08) - Lagged Deviation (Positive) x Rule in Force: 0.21* (0.12); 0.33* (0.12); 0.16 (0.13); 0.13 (0.12) - Lagged Deviation (Negative) x Rule in Force: 0.01 (0.03); -0.25** (0.12); -0.16** (0.09); -0.17** (0.08) - Samples: Countries with rules; Countries with rules; All Countries; All Countries - Cross-section unit: Country/Rule; Country/Rule; Country; Country - Constrained fiscal variable: Budget Balance constrained by rule; Budget Balance constrained by rule; Nominal Budget Balance; Nominal Budget Balance - Mean: Full sample (all columns) - Rules: Any; Threshold one std from pre-rule adoption mean; Any; Threshold one std from pre-rule adoption mean - Controls: Yes; Country fixed effects: Yes - N: 1,421; 652; 1,048; 1,048 ### Conclusions (section D) - Rules can be effective in curbing excessive deficits even when thresholds are breached via a threshold-reversion effect. - Evidence: - Positive and negative deviations relative to rule thresholds are reduced over time in a broad sample of countries with national and supranational budget balance rules. - Intensity of the threshold-reversion (magnet) effect depends on size and recurrence of deviations: - Large and infrequent deviations → rules reduce excessive deficits. - Frequent deviations, even if small → rules lose effectiveness, likely because credibility and signaling value are damaged. *Source: SECOND-GENERATION FISCAL RULES—BACKGROUND PAPERS (selected chapter content).* ### 30. Rules that are not complied with are still better than no rules when it comes to curbing ### 30. Rules that are not complied with are still better than no rules when it comes to curbing excessive deficits ### Effectiveness of fiscal rules and mean reversion - Rules that are not fully complied with can still be effective at curbing excessive deficits. - Mean-reversion in budget balances is stronger among rule adopters than rule non-adopters: - Above-average deficits converge faster to the mean for rule adopters. - Below-average deficits take longer to disappear for rule adopters. - Implication: countries with budget balance rules may be more effective at restraining above-average deficits than countries without rules, even if the rules have not always prevented such deficits historically. ### Magnet effect and calibration of rules - The rule’s threshold exerts a "pulling effect" (magnet effect), drawing budget balances toward the threshold. - This pulling effect implies rules can operate as de facto targets rather than strict ceilings. - Policy recommendation: - Calibrate budget balance rules to allow for buffers relative to levels consistent with fiscal sustainability. - Maintain fiscal space so rule adopters can provide further fiscal support during downturns without fully exhausting available room. --- ### COST OF NOT COMPLYING WITH FISCAL RULES: A EUROPEAN PERSPECTIVE ### Introduction and motivation - Adoption of rules is associated with lower sovereign spreads, especially if rules are well designed. - Existing literature focuses mainly on rule adoption; effects of rule compliance on spreads are less studied. - This paper estimates the effect of the Excessive Deficit Procedure (EDP) on sovereign spreads of EU states. ### Hypotheses on EDP effects on spreads - Spreads may be unaffected if EDP is not credible or correction mechanisms are ineffective. - Spreads may be reduced if: - EDP increases predictability of fiscal policy. - Correction actions under EDP are credible and improve fiscal sustainability prospects. - Markets view non-compliance as beneficial when supranational rules are badly-designed (e.g., fostering procyclicality). - Spreads may increase if: - EDP signals weaker fiscal discipline to markets. - EDP correction mechanisms are pro-cyclical and harm growth, undermining sustainability. - The complexity, discretion, and nontransparency of EDP decisions raise uncertainty about future fiscal outcomes. ### Key empirical findings - Sample: 28 European Union countries over the period 1999 to 2016. - Main result: sovereign spreads of countries under EDP are on average higher by 50 to 150 basis points compared to countries not under EDP. - Additional findings: - Sovereign spreads are higher for Euro area countries under EDP. - Sovereign spreads are higher for recurrent noncompliers. - Results are robust to a range of robustness checks on variables and estimators. - Estimation method: Generalized Method of Moments (GMM) used to control for endogeneity; specification controls for typical macroeconomic, fiscal, and financial determinants of spreads. ### Identification strategy and data - Identification: noncompliance is defined using EDP episodes (activation by the European Commission) rather than sole breach of the three percent deficit rule. - Over 1999–2016, there were 174 episodes of EDP in the sample. - 57 percent of EDP episodes were episodes with real time deficits above the 3 percent ceiling. - Average duration of an EDP is around 5 years. - Only three countries (Estonia, Luxembourg and Sweden) were never placed under EDP in the sample. - Rationale: EDP provides forward-looking information beyond a simple in-year breach of the 3 percent rule and involves judgement and multi-year assessments. - Data sources and choices: - Macroeconomic and competitiveness variables: IMF WEO database. - Fiscal variables: European Commission real-time database (in-year projections from Stability and Convergence Programs). - EU VIX (VSTOXX) from Bloomberg, averaged annually. - Annual frequency used to match real-time fiscal data and to filter short-term financial market noise. ### Planned versus actual fiscal adjustment under EDP - For countries under EDP (1999–2016), median planned adjustment: 0.70 percent of GDP per year. - Actual delivered adjustment for countries under EDP: 0.52 percent of GDP (3-year average change in budget balance). - For countries outside EDP: - Median average planned consolidation: 0.17 percent of GDP. - Actual outcome: a deterioration of the fiscal balance by an average of 0.29 percent of GDP. - Interpretation: EDP has constrained fiscal policy relative to non-EDP countries, but delivered less adjustment than planned. ### Econometric specification overview - Benchmark model: - Spreadi,t = α + β Spreadi,t−1 + Σβk Xk,i,t + βEDP EDP_dumm i,t + γi + εi,t - Spreadi,t: country i’s sovereign spread to the US 10-year sovereign yield. - EDP_dumm i,t: dummy taking value one when country i is under EDP, zero otherwise. - γi: country fixed effects. - Xk,i,t includes standard determinants: - Macroeconomic: real GDP growth rate, inflation, short-term interest rate. - Fiscal: net lending and public debt (both as shares of GDP). - Financial market risk aversion: EU VIX (VSTOXX). - Competitiveness: real-effective exchange rate. - Expected signs from theory: - Real GDP growth: negative on spreads. - Inflation and short-term interest rate: positive on spreads. - Net lending (higher deficit): negative coefficient expected (higher deficit → higher sovereign risk). - Debt: higher debt signals unsustainability and higher sovereign risk (text expects negative sign for net lending; debt expected to have a negative sign in the text but conceptually implies higher spreads). - EU VIX: positive on spreads. - Real appreciation (worse competitiveness): increases spreads. ### Robustness and limitations - Results robust to alternative variables and estimators. - Use of real-time fiscal projections acknowledges markets react to contemporaneous information; annual frequency limits short-term noise but may not fully capture anticipation of EDP launches. *Prepared by Federico Diaz Kalan and Adina Popescu (Strategy, Policy, and Review Department) and Julien Reynaud (Fiscal Affairs Department), based on Diaz Kalan, Popescu, and Reynaud (forthcoming).* ### 12. The Generalized Method of Moments (GMM) estimator is used to control for ### 12. The Generalized Method of Moments (GMM) estimator is used to control for endogeneity ### Methodology: endogeneity and estimator choice - Endogeneity sources identified: - Higher sovereign spreads can raise countries’ fiscal deficits and result in countries being placed under EDP. - Unobservable fiscal preferences (e.g., attachment to fiscal prudence). - Presence of the lag of the dependent variable in a dynamic specification introduces endogeneity bias. - Estimator choice and justification: - A system GMM estimator is preferred to control for endogeneity. - Evidence cited: system GMM has a lower bias and higher efficiency than other GMM estimators when the number of individuals is small and there is some persistency in the series (see Soto, 2009). - System GMM can be augmented using additional instrumental variables. - Instruments used: - Lags of the exogenous variables. - Traditional exogenous instrument variables relevant to the literature on fiscal rules (examples given: government fragmentation, checks and balance, inflation targeting). ### Estimation results and robustness checks (main findings) - Key finding: - Countries under Excessive Deficit Procedures (EDP) have sovereign spreads on average higher by 50 to 150 basis points, compared to countries complying with rules. - Summary of core estimations: - Estimation over 1999-2008 (pre-2009-11 sovereign crisis): the estimated EDP coefficient is significant and positive; spreads of countries under EDP exceed those of countries outside EDP by about 50 basis points. - Estimation over 1999-2016 (entire sample): the EDP coefficient is slightly higher (0.62), indicating a stronger effect after the sovereign crisis. - Robustness exercises: - Over 2,000 regressions (2,088 regressions) run with all possible permutations of macroeconomic and financial variables, lag structures, and instrumental variables. - Robustness result: EDP coefficients are significant in over 80 percent of the cases. - Robustness magnitude: size of the coefficient varies between 0.5 to 1.5 (meaning spreads are on average 50 to 150 basis points higher for countries under EDP). - Other main determinants of sovereign spreads (variables with expected signs and significance noted): - Short-term interest rate and the VIX identified as main determinants, consistent with the global financial cycle literature. - Lag of the long-term spread over the US enters positively and significantly. - GDP growth, inflation, government debt, net lending, and REER (CPI) included with estimated signs as reported in the regressions. ### Further results: heterogeneity and refinements (Table 2 findings) - Cost heterogeneity: - Post-crisis increase: an interaction term with EDP for the period 2009 onward supports that the cost of noncompliance is higher by about 40 basis points in the aftermath of the 2009-11 sovereign crisis. - Euro area subset (excluding Greece): Euro area countries under EDP have sovereign spreads on average higher by 85 basis points, compared to other countries in compliance. - Recurrent noncompliers: defined as a variable cumulating how many times a country has been under an EDP over the 1999-2016 period; recurrent noncompliers have spreads on average higher by 114 basis points, compared to other countries in compliance. - Selected coefficient highlights from alternative specifications (as reported): - EDP before 2009 coefficient reported as 0.78* in one specification. - EDP after 2009 coefficient reported as 1.19*** in one specification. - EDP (aggregate) coefficient reported as 0.85*** in the Euro-area specification. - Recurrent noncompliers coefficient reported as 1.14***. ### Conclusions and interpretation - Aggregate quantitative conclusion: - Based on a sample of 28 European Union countries over 1999 to 2016, controlling for endogeneity and fundamentals, sovereign spreads of countries placed under EDP are on average 50 to 150 basis points higher than countries not under EDP. - The cost associated with the EDP is higher for Euro area countries and for recurrent noncompliers. - Results hold to extensive robustness checks. - Interpretative possibilities: - Benign interpretation: EDP provides valuable information to markets—signaling fiscal plans and preferences above and beyond current fundamentals. - Less optimistic interpretation: markets may discount the ability of the EDP to correct fiscal imbalances, or the EDP’s complexity and non-transparency may create uncertainty about future fiscal policies and outcomes. *Source: sdn1804-technical-background-papers (Selected excerpts).* ### 7. Medium-term planning and the framework for managing mineral wealth have helped ### 7. Medium-term planning and the framework for managing mineral wealth have helped ### Botswana - Fiscal rule framework and institutional context - Medium-term planning and the framework for managing mineral wealth contributed to large fiscal surpluses and accumulation of substantial financial assets in the 1990s (AfDB, 2016). - Net financial savings reached 115 percent of GDP in the late 1990s. - The SBI has been adhered to since its introduction except during the early 2000s; the SBI is computed as the ratio of recurrent spending to recurrent revenues and an SBI of below 1 is used as a rule of thumb for sustainability (recurrent spending is more than financed by recurrent revenues). Recurrent spending on education and health are treated as investment in human capital when computing the SBI. - Fiscal shocks and limits - Net financial savings were partially depleted in the first half of 2000s due to the establishment of a new pension fund for government employees, following the recognition of contingent liabilities under the previous unfunded government pension plan. - The global financial crisis (GFC) hampered the diamond trade and public finances. - The 40 percent limit on the expenditure-to-GDP ratio has been too loose in good times and was breached during the GFC; the 30 percent target was also missed in 2016. - While debt limits have been respected, net financial assets fell from about 60 percent in 2008 to below 20 percent by 2011 to finance large deficits during the GFC. - The limit on gross debt has not been sufficient to guide fiscal policy and did not prevent large deficits financed by drawing down assets (IMF, 2014a). - Counterfactual and empirical evidence - SCM simulations of the debt path suggest debt would have grown at a higher pace without the rule framework. - Spending simulations provide a more ambiguous outcome. - Estimated effects fail to meet common statistical significance standards, as evidenced by the placebo test p-values. - Policy developments and proposals - Botswana’s success was driven by strong institutions and political commitment to prudent fiscal policies despite the lack of formal rules for resource management (Ossowski and others, 2008). - The latest NDP envisages a return to fiscal surpluses from 2019 onwards and proposes a formal operational fiscal rule to be implemented in the next NDP period (IMF, 2017a). NDPs have been in place since independence in 1966 and lay out government development policies and plans over the next six years; the current plan, NDP11, runs from April 2017 to March 2023. - The proposed rule targets the non-mining recurrent primary balance and envisages that the recurrent budget should only be financed from non-mineral revenues (like the SBI). - Explicit targets for allocating mineral revenues are proposed: (i) investment in physical and human capital (60 percent) and (ii) saving for future generations (40 percent). ### Brazil - Fiscal rule framework - Brazil adopted a fiscal responsibility law (FRL) in 2000, establishing numerical rules, targets, and budgetary procedures across levels of government. - Numerical rules include: i) a limit on personnel expenditure of 50 (60) percent of net current revenue for the federal government (states and municipalities), and ii) debt limits for all levels of government to be set by the senate (the senate limited state (municipal) debt at 2 (1.2) times net current revenue; no agreement reached on federal debt limit). - The FRL introduced multi-year primary balance targets for the nonfinancial public sector (NFPS), binding for the current year and indicative for the next two years. - The FRL includes procedures for reporting, monitoring, corrective actions (breaches must be corrected within the next 8 months), sanctions for noncompliance at subnational level (limits on transfers and borrowing), and escape clauses for economic slowdown, national catastrophe, or state of siege. - Fiscal performance under the FRL - Public debt was on a downward path following adoption of the FRL but the trend reversed since the GFC. - Expenditure ceilings were a true constraint primarily for subnational governments; adherence weakened since the GFC (IMF 2016b). - At the NFPS level, gross debt fell from a peak of 80 percent of GDP in 2002 to 64 percent in 2008, driven by persistently high primary surpluses achieved mainly through increased revenues and high growth (IMF 2010). - Since the GFC, NFPS surpluses declined and the government introduced frequent changes to the fiscal framework to provide flexibility, including: i) reducing targets, ii) providing off-budget stimulus through policy lending to public banks, iii) increasing the “investment adjustor” to exclude part of investment spending from targets, and iv) excluding Petrobras and Electrobras from NFPS coverage. - Counterfactual and empirical evidence - SCM simulations suggest both general government spending and NFPS debt would have been higher absent the FRL. - Estimated impacts do not meet common statistical significance standards; data limitations prevent testing the pre-GFC state-level effects. - Lessons and institutional reforms - Procedural rules improved budget reporting, accounting, and transparency (IMF 2017b). - Institutional sanctions facilitated enforcement at the subnational level and broad coverage (including subnational governments and SOEs) helped monitor fiscal vulnerabilities. - Circumventions of targets undermined fiscal discipline since the GFC; nominal primary balance targets at central level contributed to procyclical fiscal policy. - A constitutional amendment approved in 2016 introduced a cap limiting the growth of central government expenditures to the previous year’s inflation rate for the next 20 years. - An independent fiscal institution was created in 2016 to monitor fiscal and budgetary performance, in addition to accounting courts. ### Chile - Fiscal rule framework - Chile adopted a structural balance rule for the central government in 2001; revenues are budgeted at structural values net of cyclical changes in output and copper prices, and spending is adjusted to fit trends in structural revenues. - Two independent expert committees provide estimates of long-term output and copper prices used to compute structural revenues. - Savings in good times were stored in a sovereign wealth fund initially the Copper Stabilization Fund (CSF), later replaced by the Pension Reserve Fund and the Economic and Social Stabilization Fund in 2006. - The rule was inscribed into law in 2006 with a fiscal responsibility law; a fiscal council was created in 2013 to advise the government on matters related to the rule. - Methodological refinements included inclusion of molybdenum prices in 2005 and adjustments to cyclical revenue calculations in 2009 and 2011. - Fiscal performance under the rule - Net asset position grew from 3¼ percent of GDP in 2000 to 19½ percent in 2008, supported by rising copper prices. - The rule helped shield public spending from the copper boom, generating large savings used during crisis (IMF, 2012). - The rule reduced economic volatility and led to lower borrowing costs (studies cited: Larrain and Parrado, 2008; Lefort, 2006). - Repeated shocks — the crisis, collapse in copper prices, and the 2010 earthquake — led to repeated revisions of the initial surplus target of 1 percent of GDP and the rule was suspended in 2010; reinstated later, but return to structural surpluses is not expected before 2020 (Solimano and Guajardo, 2017). - Counterfactual and empirical evidence - SCM simulations suggest both public debt and spending would have remained on pre-2001 trends absent the fiscal rule. - Simulations suggest the rule helped contain the increase in public debt during the crisis (2008–09); cumulatively over 2001-11, close to 15 percent of GDP in lower debt could be attributed to the rule. - The impact of the rule somewhat declined after the crisis. - Lessons - Full delegation of forecasting of trend output and copper prices to independent expert committees helped depoliticize the rule and build credibility. - Government transparency and proactive communication about the rule’s rationale, methodology, and revisions contributed to credibility. - Lack of a well-defined escape clause proved detrimental to credibility and led to the 2010 suspension. - Absence of formal enforcement mechanisms resulted in weak compliance since the GFC. - Repeated shocks required multiple recalibrations of the structural balance rule, complicating disentangling structural and cyclical developments. ### India - Fiscal rule framework - India adopted the Fiscal Responsibility and Budget Management Act (FRBMA) in 2003 to address large deficits and rising debt. - Targets for the central government from FY 2004/05 included: i) an overall (current) deficit target of 3 (0) percent of GDP to be achieved by end-FY 2008/09, with an annual adjustment of at least 0.3 (0.5) percentage points of GDP; ii) an initial annual debt accumulation limit of 9 percent of GDP, to be reduced by 1 percentage point of GDP per year; iii) a limit of 0.5 percent of GDP on the annual rise in guarantees. - The FRBMA requires the finance minister to explain to parliament and take corrective actions in case of “substantial” budget slippages within any given year, but specifies no timeframe for corrections and no sanctions for noncompliance. - Exceptions allow breaches under national security, calamity, or other exceptional circumstances “as the Central Government may specify”. - Procedural rules require multi-year fiscal plans, and regular reporting and publication of fiscal outcomes and strategy changes. - Following FRBMA, states adopted their own FRLs; most state FRLs set targets for eliminating current deficit and reducing overall deficit to 3 percent of state GDP over the medium term. - Fiscal performance under the FRBMA - Central government finances improved significantly from the FRBMA introduction until the GFC, largely driven by increased revenues from strong growth with limited expenditure adjustment (Simone and Topalova 2009). - Some subsidy payments (2005-10) were provided through issuing special bonds excluded from rule coverage. - The FRBMA was suspended in FY 2008/09 to provide countercyclical support; the suspension continued for five years. - In FY 2012/13, the FRBMA was amended to push the deadline for meeting the 3 percent deficit target to FY 2014/15; this deadline has been further pushed to beyond FY 2018/19. - State-level experiences mirrored the federal pattern: pre-crisis improvements mainly due to growth-driven revenues and cuts in interest bills; expenditures were barely cut and post-crisis outlook remained weak. - Counterfactual and empirical evidence - SCM simulations over 2004-08 suggest debt would have been higher without the FRBMA, while simulated spending points to the opposite result. - In both debt and spending simulations, estimated impacts are statistically insignificant. *Italic line: Source: sdn1804-technical-background-papers - 7. Medium-term planning and the framework for managing mineral wealth have helped (PDF chapter).* ### 23. Despite some positive effects on budget management practices, design problems with ### sdn1804-technical-background-papers - 23. Despite some positive effects on budget management practices, design problems with ### India: FRBMA—shortcomings and reform proposals - Findings - Procedural rules in the FRBMA promoted stronger budget planning, execution, accounting, and reporting practices, although there remains room for further improvement. - Serious shortcomings identified: inability of the nominal balance rules to generate adequate fiscal buffers in good times; lack of clarity in rule coverage and the escape clause leading to circumvention; absence of a clear fiscal anchor. - 2017 Review Committee recommendations - Anchor fiscal policy with a medium-term general government debt ceiling of 60 percent of GDP (recently adopted by the government). - Set overall and current deficit targets consistent with the debt anchor, complemented with a “buoyancy” clause requiring a larger fiscal effort in boom years. - Adopt more specific escape clause triggers that allow for limited deviations from the targets and require returning to the original targets in a year. - Establish a fiscal council tasked with providing independent fiscal forecasts, policy and performance assessments (including on rule compliance), and advice on the triggering of buoyancy and escape clauses (FRBM Review Committee 2017). - Institutional/implementation note - The Committee also recommended that state-level fiscal policy be consistent with general government debt targets. The recently formed 15th Finance Commission has been tasked with assigning debt limits across states. ### Netherlands: rule framework, performance, and lessons - Fiscal rule framework (established 1994) - Core features: coalition agreement for the government’s 4-year term specifying i) multiannual expenditure ceilings in real terms for the central government, social security, and healthcare, and ii) desired change in the tax base and tax rates. - Revenues can fluctuate over the cycle, while expenditure ceilings are fixed. - Procedural rules require ministries to propose corrective actions if spending overruns are forecast; any additional tax relief must be compensated by tax hikes, or vice versa. - 2011: a “signaling margin” of 1 percent of GDP deviation from the planned general government deficit path was adopted, triggering additional consolidation measures. - 2014: a structural balance rule adopted in line with the Fiscal Compact, subject to monitoring by the independent fiscal council (CPB). - Institutions - CPB provides medium-term macroeconomic projections and evaluates budgetary implications of political party programs before elections. - A non-partisan national advisory group (SBR) provides nonbinding but influential recommendations on budgetary policy. - Annual budgeting follows a top-down process; line ministries responsible for budgetary control within agreed ceilings. - Fiscal performance under the rule - The debt ratio was almost halved between 1993 and 2007 to 42 percent of GDP, and spending declined by 10 percentage points to 42 percent of GDP. - Expenditure ceilings were breached in the early 2000s and right before the GFC. - Following the GFC and the Eurozone crisis, the debt ratio rose by over 25 percentage points of GDP between 2007 and 2014, in part due to financial sector interventions. - Lessons - Design features credited for success: i) broad coverage of expenditure ceilings; ii) independent macro-fiscal forecasts by the CPB improving transparency and credibility; iii) coalition agreements enhancing political buy-in and adherence. - Limitations: calibration of expenditure ceilings has not always ensured sufficient build-up of fiscal buffers in good times, and often led to procyclicality. To allow a stronger countercyclical response, unemployment and social assistance benefits were excluded from expenditure coverage during the GFC (2009-10). - The current coalition agreement (October 2017) also excludes unemployment and social assistance benefits from the fixed expenditure ceilings to promote a countercyclical fiscal policy. ### Norway: fiscal rule framework, performance, and lessons - Fiscal rule framework (adopted 2001; GPFG created 1996) - Three pillars: - State’s net cash flow from the oil industry is entirely transferred to the Government Pension Fund Global (GPFG). - Annual transfers from GPFG to the central government budget targeted at the expected long-term real return on GPFG assets (estimated at 4 percent at inception). - Fiscal rule: central government structural non-oil deficit financed by oil-related revenue transferred from the GPFG (targeted at 4 percent of GPFG assets). - Guidelines allow deviations from the 4 percent transfer rule over the business cycle for countercyclical policy. - In case of major changes in GPFG value, transfers can be smoothed over several years to avoid excessive spending volatility. - Fiscal performance under the rule - Framework insulated the budget from short-term fluctuations in oil revenue and ensured significant redistribution toward future generations. - GPFG assets grew fivefold between 2001 to 2015 to over 250 percent of mainland GDP. - The structural non-oil deficit was raised during the early 2000s financial crisis and the GFC, and lowered well below the 4 percent threshold afterwards; framework allowed countercyclical policy during the 2014-16 oil price collapse. - Since 2011, there has been a steady increase in the structural non-oil deficit as a share of mainland GDP, although its level remained significantly below the 4 percent target. - Higher than expected oil production and prices until 2014, and the exponential increase in GPFG assets, meant real returns significantly exceeded resources needed for the budget; the 4 percent return threshold ceased to provide effective operational guidance for government fiscal policy. - In light of trends and declines in oil prices, the expected real rate of return of GPFG assets was reduced to 3 percent in 2017, a level more constraining for current fiscal policy (MoF Norway 2017). - Lessons - Effectiveness stems from simplicity, flexibility, and political commitment to comply with the rule within this flexibility. - Estimating the value of GPFG assets and measuring the structural balance have been challenging and revised significantly over time, but parsimony aids communication. - Political commitment has been key in the absence of formal monitoring and enforcement mechanisms. ### Sweden: framework, performance, and lessons - Fiscal rule framework (established 1997) - Four core elements: 1) Expenditure ceiling for central government (including pensions) set in nominal terms for the current and next three years, including a budget buffer to deal with unforeseen cyclical expenditures. 2) Budget surplus target for the general government of 1 percent of GDP to be achieved on average over the business cycle. 3) Balanced budget requirement (with possibility to set rainy day funds) for local governments, which undertake half of general government spending. 4) A pension system designed to be self-financed and sustainable (through automatic adjustments). - Compliance with the surplus target is monitored via several indicators, including backward and forward looking averages of the actual balance and the current structural balance. There are no formal sanctions or correction mechanisms for past deviations. - 2007: independent fiscal council established to assess ex-post sustainability and consistency with targets. - 2016 changes: parliament introduced a benchmark for public debt of 35 percent of GDP, revised down the surplus target for the general government from one to one-third percent of GDP effective 2019, and agreed that the framework would be reviewed every 8 years. - Fiscal performance under the rule - Expenditure ceilings have been met regularly. - Budget achieved surpluses above 1 percent of GDP in good times, compensating for lower balances in bad times (early 2000s and during the GFC), helping avoid procyclicality. - General government debt was almost halved between 1996 and 2012 to 38 percent of GDP. - Deficits and debt rose in 2013-14; the fiscal council assessed a breach of the surplus target in 2015, but surpluses have been recorded since then, reversing the 2013-14 increase in debt. - Lessons - Success factors: i) broad coverage of rules beyond the central government, complemented by sub-central rules; ii) a well-designed expenditure rule consistent with an over-the-cycle surplus target allowing automatic stabilizers and discretionary flexibility; iii) an independent fiscal council enhancing accountability and credibility; iv) broad political and public consensus cementing respect for the rules despite absence of formal enforcement mechanisms. ### Switzerland: “debt brake” framework, performance, and lessons - Fiscal rule framework (adopted by popular vote; took effect 2003) - Targets a central government structural budget balance; sets ex-ante central government expenditure ceilings equal to predicted “structural” revenues adjusted by a cyclical factor. - Cyclical factor computed as ratio of trend real GDP (estimated by an HP filter) to predicted real GDP. - Ex-post, the expenditure ceiling is recomputed using actual rather than predicted revenues. - Any deviation of actual spending from the ex-post expenditure ceiling is accumulated in a notional compensation account. - If the negative balance in this account exceeds 6 percent of expenditures, corrective measures are required by law to reduce the balance below this level within three years. - No mechanism specified for positive balances. - An escape clause, approved by parliamentary supermajority under “exceptional circumstances”, allows for “extraordinary expenditures” through supplementary budgets. - Since 2010, deficits from extraordinary expenditures are accumulated in an amortization account and need to be redeemed over the next six years by running structural surpluses through expenditure cuts, once the compensation account balance becomes non-negative. - Fiscal performance under the rule - Framework has helped reduce debt and avoid structural deficits even during the GFC. - Initial implementation challenges produced undesired structural deficits partly driven by measurement errors with the HP filter, but the framework mostly led to structural surpluses, which have been used to further reduce debt. - There has never been a need for corrective actions thanks to surpluses. - The framework has prevented procyclical fiscal policy. - Lessons - Success attributed to reconciling flexibility and sustainability via a parsimonious single numerical target, cyclical adjustment facilitating automatic stabilizers, and a well-defined escape clause allowing discretionary spending under exceptional circumstances (for example, migration-related spending in 2017). - Automatic correction of past budget slippages (not operationalized yet due to surpluses) enhances credibility. - Debt brake covers only the central government (excluding social security); most cantons have their own budget balance rules, enhancing fiscal discipline at the general government level. - Nominal balance rules at the cantonal level have often led to procyclicality, complicating consistent stabilization policy between the federal government and cantons. *International Monetary Fund — Second-Generation Fiscal Rules: Background Papers (excerpts).* ### 38. Nevertheless, there has been some concerns that the rule may be too strict, unduly ### Annex. Counterfactual Analyses with the Synthetic Control Method ### Concerns about strict fiscal rules and expert committee findings - Some concerns that the rule may be too strict, unduly constraining debt financing for investment spending (IMF 2009) and overburdening monetary policy by providing less fiscal support than envisaged under the rule (IMF 2016d). - An expert committee appointed by the government in 2017 examined whether savings under the structural surpluses could be used in the future to increase expenditures rather than to reduce debt. - The committee recommended maintaining debt reduction in view of the anticipated normalization of inflation and interest rates (previously underestimated), and a decline in budget underruns. - The committee added that there could be room for using the savings to also reduce the tax burden (FDF 2017). - Note from figure caption: Data is unavailable for India. ### The method (SCM) - The SCM is a data-driven procedure to build counterfactual outcomes for individual units (here, a country) subject to a specific treatment (here, the introduction of a rule). - A “synthetic country” is constructed to reproduce relevant pre-treatment features of the country of interest and serves as the counterfactual to assess the rule’s impact. - Creation of the synthetic control is achieved by calculating a weighted average of countries in the control group (here countries with no fiscal rules) that minimizes distance with the country of interest along predefined criteria. ### Matching criteria used for the synthetic control - Chosen matching criteria: - the level of debt and spending (6,5, and 1 year) before the adoption of the rule, - the age dependency ratio, - real GDP per capita, - the interest rate-growth differential, - the output gap, - a political fractionalization index and the number of years left in the current term of the executive from the Database of Political Institutions (DPI), - the share of natural resource exports in total exports. - Rationale: These criteria cover a large spectrum of potential drivers of fiscal performance. ### Pros and cons of SCM for this study - Pros: - Addresses selection bias. - Applicable to individual countries. - Provides a time-varying assessment of performance. - Asymptotically robust to time-varying unobserved determinants (Abadie et al., 2010). - Cons and caveats: - SCM results could be affected by structural changes in the control group (independent from the treatment) during the post-treatment period, which is 10 years after rule adoption. - Bias can arise if one or several countries in the control group experience significant idiosyncratic shocks affecting fiscal paths during the post-treatment period. - Systematic checks are required (randomized placebo tests on the control sample) to ensure estimated impacts are not driven by confounding factors (see Abadie et al. 2010). - Proliferation of fiscal rules reduces the control pool in recent years, limiting SCM applicability; simulations could not be conducted in the absence of suitable controls for the Netherlands, Norway, Sweden and Switzerland. - Caution is needed in attributing the decline in gross debt entirely to the adoption of fiscal rules (or attributing the absence of decline to ineffectiveness of the rules) because stock-flow adjustments (off-budget operations, changes in financial assets, exchange rate movements, or other factors) could also affect debt dynamics. ### Data sources - Primary sources: - IMF’s World Economic Outlook (WEO) database: debt, spending, real GDP growth, interest rate payments, output gap. - Various World Bank databases: age dependency ratio, political economy variables, GDP per capita in USD. - Supplementary sources: - When missing, WEO debt series completed with data from the IMF’s Global Debt Database (Mbaye et al., forthcoming). - For Brazil: non-financial public sector debt and general government spending series collected from the Brazilian Ministry of Finance and the World Development Indicators. *Source: SECOND-GENERATION FISCAL RULES—BACKGROUND PAPERS, International Monetary Fund.* --- _Source: https://www.imf.org/-/media/files/publications/sdn/2018/sdn1804-technical-background-papers.pdf_