## sdnea2025004

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### Overview and context
- Over the past two decades, fiscal policy responses to global shocks increased public debt-to-GDP ratios and shrank fiscal space.
- Normalization of monetary policy and the rise in real interest rates reversed a decade of favorable financing conditions, increasing debt service burdens and vulnerabilities to future shocks.
- Fiscal rules are long-lasting numerical limits on key budget aggregates designed to contain excessive spending and the rise in debt; empirical evidence suggests fiscal rules can foster budgetary discipline and signal commitment to sound fiscal management.
- Average compliance with fiscal rules is about 60 percent across countries; noncompliance was widespread even before the pandemic and widened amid the crisis.

### Recent developments and data coverage
- As of the end of 2024, 122 economies have adopted numerical fiscal rules, representing a 6 percent increase since the pandemic.
- The updated IMF Fiscal Rules and Fiscal Council databases (2025 update) cover 123 economies in the fiscal rule database (of which 1 country no longer adopts rules as of end 2024) and 54 fiscal councils operational as of the end of 2024 on a de jure basis.
- Since the pandemic, over two-thirds of countries with fiscal rules have modified their frameworks; revisions often included allowing automatic stabilizers to operate and embedding escape clauses for severe shocks.
- Despite greater flexibility, compliance remains limited: fewer than two-thirds of countries adhere to their deficit rules on average, with lower shares for emerging market and developing countries and for debt rules.

### Key findings on rule design, compliance, and institutions
- Revisions since the pandemic often have not translated into better compliance following the expiration of escape clauses; many countries lack robust corrective mechanisms and supportive fiscal institutions (independent oversight, unbiased macro-fiscal forecasts).
- Persistent deviations from fiscal rule limits are common; many countries lack credible adjustment paths to return to rule limits.
- Empirical associations:
  - Stronger fiscal rules and well-functioning fiscal councils correlate with smaller fiscal surprises, lower sovereign spreads, and a more disciplined fiscal policy discourse.
  - Rules with strong correction mechanisms durably reduce sovereign spreads by 30−75 basis points.
  - The estimated “strength” index shows a correlation coefficient of 0.8 with the European Commission’s index for EU countries.

### Policy prescriptions: three-element multi-pronged strategy
- A risk-based fiscal anchor:
  - Tailor the anchor to a country’s debt-carrying capacity.
  - Set a quantified fiscal anchor that accounts for government-facing risks and link it to annual operational limits on expenditures or the budget balance.
  - For countries with high uncertainty on debt carrying capacity or undergoing debt restructuring, prefer expenditure or deficit ceilings to stabilize debt rather than anchoring to a specific debt level.
  - Review the fiscal anchor periodically every four to five years.
- Robust correction mechanisms:
  - Predefined triggers, timelines, and policy responses to potential slippage guide return to rule limits and reduce sovereign spreads.
  - Corrective measures should specify triggers, timeframes, magnitudes, and reporting requirements; examples show corrective mechanisms with one-and-a-half to three year timeframes.
  - Empirical six-country analysis (Armenia, Costa Rica, Cyprus, Czech Republic, Poland, Slovak Republic) using synthetic control finds sovereign spreads declined by about 10 percent (on average 30 basis points) after six months and more than 25 percent (on average 75 basis points) after one year relative to controls.
- Supportive fiscal institutional frameworks:
  - Realistic macro-fiscal forecasts, expenditure controls, strong links between fiscal rules and MTFFs, and independent fiscal oversight improve credibility and enforcement.
  - Strengthening fiscal rules and fiscal councils is associated with reduced deficit bias and better fiscal outcomes:
    - Political discourse on fiscal restraint improved by about 0.7 percentage points where frameworks are stronger.
    - Surprises in primary deficits decline by 0.4 and 0.2 percentage point of GDP when rule strength improves from the 25th percentile to the 75th percentile.
    - Debt surprises reduce by 2 and 0.6 percentage points of GDP under similar improvements.
    - Increasing debt-rule strength from the 25th to the 75th percentile corresponds to a 6 percent reduction in deviations from debt rule limits.
    - More effective fiscal councils associate with a 1.5 percent of debt-to-GDP ratio decrease in excessive deviations from debt rule limits.

### Guidance on revising rules to accommodate investment and priority spending
- General guidance:
  - Blanket exclusions of priority spending or prolonged delays in adjustment can erode rule integrity and jeopardize debt sustainability.
  - Well-calibrated rules, paired with strong investment management frameworks, can preserve credibility and foster compliance.
- Model-based simulations (dynamic general equilibrium framework; 1 percentage point of GDP additional investment for 10 years; cumulative cost about 12 percent of GDP over 15 years):
  - Low-debt countries (reference debt about 60 percent of GDP):
    - Modest easing of rules can yield sustained output gains with manageable debt dynamics.
    - Easing could temporarily increase debt by 8–10 percentage points of GDP and eventually return to a downward path; cumulative multipliers above 1.0.
  - High-debt countries (reference debt of 110 or 140 percent of GDP):
    - Debt-financed investment raises debt-to-GDP by 12–24 percentage points and yields muted output effects (cumulative multipliers below 0.5).
    - Easing fiscal rules is not viable; additional spending should be offset by higher revenues or expenditure reprioritization to preserve sustainability.
  - Countries with limited fiscal space (intermediate/high debt):
    - Faster fiscal adjustment risks abrupt current spending cuts; lengthening adjustment horizons may create space but heighten debt distress risk.
    - EU example: lengthening the adjustment horizon from four years to seven years is estimated to provide €700 billion in fiscal room between 2025 and 2031.
- Options and risks for accommodating investment:
  1. Temporary easing of fiscal rule limits followed by tighter limits after the program ends — benefit: reduces misclassification risk; risk: easing could become permanent.
  2. Temporary exclusion of additional investment paired with immediate tightening of nonpriority spending — benefit: allows immediate tightening of nonpriority spending; risk: misclassification and prolonged investment programs without offsets.

### Designing and implementing corrective mechanisms (design details)
- Triggers:
  - Can be ex post (after breach) or preemptive (early warning); progressive triggers with thresholds can require larger adjustments as debt rises.
  - Examples: Ecuador and Spain mandate corrective actions when outcomes are close to rule limits; Czech Republic sets debt-to-GDP thresholds with escalating adjustments.
- Timeframes:
  - Many rules require corrective actions within one-and-a-half or two years; some permit up to three years; the EU allows longer adjustment periods in some cases.
- Magnitude and measures:
  - Approaches vary: restoring current deviations, unwinding cumulative deviations, quantitative adjustments (e.g., 0.5 percentage points of GDP), or prespecified measures (wage freezes, spending cuts).
  - Examples: Switzerland’s notional account triggers measures if negative balance exceeds 6 percent of expenditure; Slovak Republic requires balanced budget in following fiscal year under certain conditions.
- Implementation guidance:
  - Enshrine mechanisms in legislation, require updated MTFF reports and parliamentary presentation, align pace of adjustment with sovereign risks, and centralize enforcement for subnational rules.

### Strengthening fiscal institutions and governance
- Fiscal oversight shortcomings:
  - Less than half of countries had independent fiscal councils by end-2024.
  - Many fiscal councils, particularly in EMDEs, do not communicate effectively or publish regular assessments; some lack operational independence or face budget constraints.
- Recommended institutional measures:
  - Ensure fiscal councils have clear mandates, resources, budget safeguards, timely access to information at no cost, and direct media engagement (webpages, press events, publications).
  - Link MTFFs closely to fiscal rules and annual budgets; publish MTFF before the budget and include fiscal risks and measures to achieve targets.
  - For small developing countries, leverage existing entities (general audit office or parliamentary budget committee) to perform oversight functions.

### Diagnostic and analytical contributions
- Updated and expanded IMF datasets on Fiscal Rules and Fiscal Councils with broader coverage and new data on compliance, escape clauses, and fiscal council communications.
- Developed a “strength” index for fiscal rules using four institutional criteria:
  1. Statutory or legal basis of the fiscal rule,
  2. Monitoring of fiscal rules,
  3. Enforcement and correction mechanisms,
  4. Flexibility and resilience to shocks.
- Index construction:
  - Each indicator score is standardized between 0 and 1, with weights assigned on each rule; scores are summed to create a single index proxying rule strength.
  - Validation: the estimated strength index correlates at 0.8 with the European Commission’s index for EU countries.
- Calibration guidance for sustainable debt limits and a framework to assess debt-carrying capacity when setting prudent fiscal anchors.
- Analytical evidence linking corrective mechanisms and stronger rules/councils to reduced sovereign spreads, lower forecast bias, and less expansionary political rhetoric.

### Practical implications for policymakers (actionable checklist)
- Strengthen fiscal guardrails now to rebuild buffers amid rising spending pressures (defense, population aging, sustainable development needs) and potential declines in foreign aid for developing countries.
- Design risk-based fiscal anchors that account for debt-carrying capacity and country-specific risks, and link anchors to operational annual limits.
- Institute robust, prespecified corrective mechanisms with clear triggers and timelines to restore compliance when slippage occurs.
- Bolster fiscal institutions—publish realistic MTFFs ahead of budget cycles, ensure independent fiscal oversight, and tighten expenditure controls—to improve credibility and enforcement.
- When revising rules to accommodate investment:
  - Low-debt countries: allow targeted easing within debt-stabilizing bounds for investment.
  - High-debt countries: require offsets (higher revenues or lower other spending) to avoid jeopardizing debt sustainability.
- Improve expenditure prioritization and public investment management frameworks to enhance investment efficiency within fiscal rules.

### Key statistics and calibration points
- Average compliance with fiscal rules: about 60 percent.
- As of the end of 2024: 122 economies have adopted numerical fiscal rules; databases cover 123 economies (1 country no longer adopts rules as of end 2024) and 54 fiscal councils operational on a de jure basis.
- Persistent deviations four years after the pandemic: median of 2.0–2.5 percentage points of GDP above fiscal rule limits for about 40 percent of advanced economies and 60 percent of EMDEs.
- Public debt has surpassed debt-rule ceilings by an average of 25 percentage points of GDP in most countries.
- Strength index validation: correlation coefficient of 0.8 with the European Commission’s index for EU countries.
- Sovereign spread compression from strong correction mechanisms: 30−75 basis points (empirical six-country analysis reports about 10 percent or on average 30 basis points after six months and more than 25 percent or on average 75 basis points after one year relative to controls).
- Simulation parameters:
  - Investment shock: 1 percentage point of GDP (from 4 percent of GDP to 5 percent of GDP) for 10 years.
  - Cumulative cost of public investment program: about 12 percent of GDP over 15 years.
  - Low-debt reference: about 60 percent of GDP; temporary debt increase of 8–10 percentage points of GDP possible with eventual decline.
  - High-debt references: 110 or 140 percent of GDP; additional debt-financed investment could increase debt-to-GDP ratios by 12–24 percentage points; cumulative multipliers below 0.5.
  - EU adjustment example: lengthening adjustment horizon from four years to seven years estimated to provide €700 billion in fiscal room between 2025 and 2031.
- Institutional adoption statistic reiterated: As of the end of 2024, more than 120 economies and 50 countries have adopted fiscal rules and established fiscal councils.

*Staff Discussion Note: Fiscal Guardrails against Rising Debt and Looming Spending Pressures — INTERNATIONAL MONETARY FUND*

### EXECUTIVE SUMMARY_____________________________________________________________________________________________ 3

### sdnea2025004 - EXECUTIVE SUMMARY

### Overview and context
- Over the past two decades, fiscal policy responses to global shocks (global financial crisis, COVID-19 pandemic) increased public debt-to-GDP ratios and shrank fiscal space.
- The normalization of monetary policy and the rise in real interest rates have reversed a decade of favorable financing conditions, increasing debt service burdens and vulnerabilities to future shocks.
- Fiscal rules are long-lasting numerical limits on key budget aggregates designed to contain excessive spending and the rise in debt; empirical evidence suggests fiscal rules can foster budgetary discipline and signal commitment to sound fiscal management.
- Average compliance with fiscal rules is about 60 percent across countries; noncompliance was widespread even before the pandemic and widened amid the crisis.

### Recent developments and data coverage
- As of the end of 2024, 122 economies have adopted numerical fiscal rules, representing a 6 percent increase since the pandemic.
- The updated IMF Fiscal Rules and Fiscal Council databases (2025 update) cover 123 economies in the fiscal rule database (of which 1 country no longer adopts rules as of end 2024) and 54 fiscal councils operational as of the end of 2024 on a de jure basis.
- Since the pandemic, over two-thirds of countries with fiscal rules have modified their frameworks; revisions often included allowing automatic stabilizers to operate and embedding escape clauses for severe shocks.
- Despite greater flexibility, compliance remains limited: fewer than two-thirds of countries adhere to their deficit rules on average, with lower shares for emerging market and developing countries and for debt rules.

### Key findings on rule design, compliance, and institutions
- Revisions since the pandemic often have not translated into better compliance following the expiration of escape clauses; many countries lack robust corrective mechanisms and supportive fiscal institutions (independent oversight, unbiased macro-fiscal forecasts).
- Persistent deviations from fiscal rule limits are common, and many countries lack credible adjustment paths to return to rule limits.
- Stronger fiscal rules and well-functioning fiscal councils correlate with:
  - Smaller fiscal surprises,
  - Lower sovereign spreads,
  - A more disciplined fiscal policy discourse.
- Strong correction mechanisms durably reduce sovereign spreads by 30−75 basis points, according to the note’s analysis.

### Policy prescriptions and design elements to improve compliance and mitigate sovereign risk
- The note emphasizes a multi-pronged strategy drawing on three key elements to improve compliance with fiscal rules amid growing policy uncertainty:
  - A risk-based fiscal anchor:
    - Tailor the anchor to a country’s debt-carrying capacity.
    - Set a quantified fiscal anchor that accounts for government-facing risks and link it to annual operational limits on expenditures or the budget balance.
    - Goals: gradually build fiscal buffers and avoid debt distress.
    - For countries with high uncertainty on debt carrying capacity or undergoing debt restructuring, it may be more practical to set expenditure or deficit ceilings to stabilize debt or place debt on a downward path rather than anchoring to a specific debt level.
    - The fiscal anchor should be easy to communicate, aligned with institutional capacity, and complemented by a range of indicators to monitor debt risks.
  - Robust correction mechanisms:
    - Predefined triggers, timelines, and policy responses to potential slippage can guide the return to rule limits and reduce sovereign spreads.
    - Evidence shows rules with strong correction mechanisms reduce spreads by 30−75 basis points.
  - Supportive fiscal institutional frameworks:
    - Include realistic macro-fiscal forecasts, expenditure controls, strong links between fiscal rules and medium-term fiscal frameworks (MTFFs), and independent fiscal oversight.
    - Stronger institutions and rules are associated with smaller fiscal surprises, lower sovereign spreads, and a more disciplined fiscal policy discourse.

### Guidance on revising rules to accommodate investment and priority spending
- Simulations and model-based analysis indicate:
  - Blanket exclusions of priority spending or prolonged delays in adjustment can erode rule integrity and jeopardize debt sustainability.
  - Low-debt countries could ease rules within debt-stabilizing limits to scale up investment.
  - High-debt countries with constrained fiscal space should match additional spending with higher revenues or expenditure reprioritization; otherwise, loosening fiscal rules would put debt sustainability at risk.
  - Well-calibrated rules, paired with strong investment management frameworks, can preserve credibility and foster compliance.

### Diagnostic and analytical contributions of the note
- Presents updated and expanded IMF datasets (Fiscal Rules and Fiscal Councils) with broader country coverage and new data on compliance, escape clauses, and fiscal council communications.
- Develops a “strength” index for fiscal rules using four institutional criteria:
  1. Statutory or legal basis of the fiscal rule,
  2. Monitoring of fiscal rules,
  3. Enforcement and correction mechanisms,
  4. Flexibility and resilience to shocks.
- Provides calibration guidance for a country’s sustainable debt limit and a framework to assess debt-carrying capacity when establishing a prudent fiscal anchor.
- Analyzes the impact of correction mechanisms on sovereign spreads and demonstrates the correlation between stronger rules/councils and reduced fiscal projection bias and less expansionary political rhetoric.

### Practical implications for policymakers
- Strengthen fiscal guardrails now to rebuild buffers amid rising spending pressures (defense, population aging, sustainable development needs) and potential declines in foreign aid for developing countries.
- Design risk-based fiscal anchors that account for debt-carrying capacity and country-specific risks, and link these anchors to operational annual limits.
- Institute robust, prespecified corrective mechanisms with clear triggers and timelines to restore compliance when slippage occurs.
- Bolster fiscal institutions—publish realistic MTFFs ahead of budget cycles, ensure independent fiscal oversight, and tighten expenditure controls—to improve credibility and enforcement.
- When revising rules to accommodate investment, differentiate policy responses by initial debt position:
  - Allow targeted easing within debt-stabilizing bounds for low-debt countries,
  - Require offsets (higher revenues or lower other spending) for high-debt countries.

*Staff Discussion Note: Fiscal Guardrails against Rising Debt and Looming Spending Pressures — INTERNATIONAL MONETARY FUND*

### Annex 2). Each indicator score is standardized between 0 and 1, with weights assigned on each rule.

### sdnea2025004 - Annex 2). Each indicator score is standardized between 0 and 1, with weights assigned on each rule.

### Index construction
- Each indicator score is standardized between 0 and 1.
- Weights are assigned on each rule.
- The scores are summed up to create a single index, which serves as a proxy for the strength of fiscal rules.

### Validation and correlation
- The estimated “strength” index shows a high correlation (with a correlation coefficient of 0.8) with the European Commission’s index for EU countries.

*https://www.imf.org/-/media/files/publications/sdn/2025/english/sdnea2025004.pdf*

### Box 1. Assessing Compliance with Fiscal Rules

### Box 1. Assessing Compliance with Fiscal Rules

### Challenges in assessing compliance
- Heterogeneity in design and coverage of fiscal rules (exclusions of local governments, off-budget entities, or investment spending) complicates cross-country comparisons.
- Need to account for activation of escape clauses or temporary suspensions (widely used during the pandemic).
- Many rules are forward-looking, so current deficits or debt levels may exceed targets applicable only in the future.
- Compliance involves procedural requirements (for example, presenting fiscal plans or adhering to adjustment paths), not only numerical adherence.

### Indicators and empirical approach
- The Staff Discussion Note proposes complementary indicators:
  - Direct assessments from national (or supranational) authorities and IMF country teams (from the IMF Fiscal Rules Database).
  - A constructed metric based on observed deviations of fiscal outcomes from rule thresholds, accounting for active escape clauses or suspensions.
- Constructed indicators show a high degree of correlation with other studies despite methodological differences.

### Persistent deviations: magnitudes and drivers
- Fiscal deficits four years after the pandemic continue to exceed fiscal rule limits by a median of 2.0–2.5 percentage points of GDP for about 40 percent of advanced economies and 60 percent of EMDEs.
- In most countries, public debt has surpassed debt-rule ceilings by an average of 25 percentage points of GDP.
- Drivers of persistent deviations:
  - Severe macro-fiscal shocks (for example, global financial crisis, COVID19).
  - Design limitations of fiscal rules (complex or internally inconsistent targets; limited independent oversight).
  - Political economy constraints and lack of political will; extended period of low interest rates weakened market discipline.

### Fiscal-rule strength, oversight, and escape clauses
- Overall strength of fiscal rules has improved across advanced economies and EMDEs, reflecting more desirable design features, including escape clauses embedded in legislation.
- Limited fiscal oversight persists: less than half of countries had independent fiscal councils to monitor public finances by the end of 2024.
- Majority of countries (with an even smaller share among EMDEs) do not have corrective mechanisms to manage noncompliance.
- Escape clause practices:
  - Many frameworks prespecify activation triggers but often do not specify the duration of suspensions.
  - This lack of duration specification often results in extensions of 3 to 4 years even after severe shocks have subsided.
  - Lack of reporting on strategies to return to compliance adds uncertainty to fiscal policy.

### Recent revisions to fiscal-rule frameworks (stylized)
- Governments have adopted various approaches to improve compliance:
  - New debt rules (examples cited: Chile and Colombia).
  - First fiscal responsibility law (example cited: Dominican Republic).
  - Overhauls allowing differentiated adjustments (example cited: new EU fiscal rules).
  - Exclusions of entities or expenditures from rules (examples cited: Armenia, Costa Rica).
  - Extended horizons to reach fiscal anchors (example cited: countries in Eastern Caribbean Currency Union).
  - Greater flexibility via multiyear fiscal plans (example cited: India).

### Designing fiscal rules to improve compliance and mitigate sovereign risk
- Policy objective: strike a balance between fiscal discipline (debt sustainability, mitigating sovereign risk) and sufficient buffers for stabilization and productive investment.
- Key areas for reform:
  - (1) Selecting a prudent fiscal anchor within a risk-based fiscal framework.
  - (2) Establishing a robust correction mechanism specifying fiscal adjustment paths.
  - (3) Strengthening fiscal institutions.

### Selecting a fiscal anchor — options, merits, and challenges
- Debt anchor
  - Observable, easy to communicate, relates directly to debt sustainability risks.
  - Should have broad coverage for the general government (and in some cases include government-guaranteed debt for state-owned enterprises).
  - Challenges: countries with high debt struggle to commit credibly; sustainable debt limit varies over time and is sensitive to interest rates and growth differentials.
  - Illustrative examples: Angola (60 percent of GDP), Chile (45 percent of GDP), Ecuador (long-term 40 percent after 2032 and intermediate targets), WAEMU (70 percent of GDP).
  - Some countries use intermediate targets (examples cited: Barbados, Ecuador); others stabilize or put debt on a declining path without a fixed ratio (examples cited: Australia, United Kingdom).
- Budget balance
  - Observable, easy to communicate, partially linked to debt sustainability risks but may contribute to procyclical spending.
  - Useful where anchoring a prudent debt level is challenging; can help ensure debt remains on a declining path.
  - Example: Sri Lanka sets a primary expenditure ceiling in law and uses a primary balance level in its MTFF as the fiscal anchor.
  - Limitation: may not fully account for risks from financial stress or unidentified debt.
- Net financial assets
  - Floor on net financial assets (gross government debt net of liquid financial assets) suits resource-rich countries with financial buffers.
  - Accounts for precautionary buffers and stable primary expenditures, but dual anchors (assets floor and gross debt ceiling) can be complex and lead to inefficient “borrow to save” outcomes.
  - Anchoring net worth is difficult due to asset valuation variability.
- Interest expense
  - Threshold on (net) interest expense as a share of revenues or nominal GDP captures debt-servicing capacity; low rates permit higher debt.
  - Limitation: interest expense is a lagging indicator and may not capture future risks; in LIDCs concessional financing can distort the signal.
  - Example: net interest payments in the United States averaged 2 percent of GDP before the pandemic and increased to 3.6 percent of GDP in 2024.
- Sovereign spreads
  - Market-based indicator reflecting expectations of future policies and sovereign risks; can prevent excessive borrowing.
  - Limitations: not all countries have liquid sovereign bond markets; spreads are less directly controllable by government and may be distorted.

### Risk-based fiscal-rule framework and calibration
- A risk-based fiscal rule:
  - Sets a quantified medium-term debt anchor linked to annual operational limits (expenditure or deficit ceilings) to build buffers and avoid debt distress.
  - Calibrates expenditure or deficit ceilings so debt reaches the anchor with high likelihood over the medium term.
- Practical design notes:
  - The risk-based fiscal anchor should be reviewed periodically every four to five years to reflect changes in growth prospects and long-term interest rates; avoid frequent revisions that undermine credibility.
  - Determining a maximum sustainable debt (sustainable debt limit) can use cross-country analysis or estimates based on maximum achievable primary surplus.
  - Debt limits vary significantly across countries and over time; a fixed exogenous limit is often unsuitable.
  - Complementary tools for assessing debt risk include the IMF Sovereign Risk and Debt Sustainability Frameworks and the IMF Debt-at-Risk framework (estimates full distribution of debt outlook one to five years ahead).
  - The fiscal anchor can be set so the debt-at-risk (95th percentile three years ahead) would not exceed the maximum sustainable debt level with high confidence.

### Establishing corrective mechanisms
- Corrective mechanisms:
  - Specify fiscal actions when rules are not adhered to (activated when exiting escape clause or deviating from limits).
  - Forms include additional reporting and concrete adjustment plans with specific revenue and expenditure measures.
- Empirical evidence (six-country analysis)
  - Analysis covers six countries with prespecified correction mechanisms: Armenia, Costa Rica, Cyprus, Czech Republic, Poland, and Slovak Republic.
  - Empirical strategy: synthetic control approach.
  - Results:
    - Sovereign spreads decreased in countries with fiscal rules that include thresholds and corrective measures, relative to synthetic controls.
    - On average, sovereign spreads declined by about 10 percent (or on average 30 basis points) after six months and more than 25 percent (or on average 75 basis points) after one year compared to the control group.
    - These compression effects are further confirmed using alternative empirical approaches.

*Source: Box 1, "Assessing Compliance with Fiscal Rules," STAFF DISCUSSION NOTES — Fiscal Guardrails against Rising Debt and Looming Spending Pressures.*

### 1. Cyprus                                   2. Poland

### 1. Cyprus                                   2. Poland

### Design of corrective mechanisms: triggers, timeframe, magnitude, and measures
- Trigger
  - Can be triggered ex post based on actual deviations when fiscal rules are breached or noncompliant, or preemptively as early warnings before rule limits are breached.
  - Example frameworks with both preemptive and reactive triggers: European Fiscal Compact.
  - Ecuador and Spain mandate corrective actions when fiscal outcomes are close to the fiscal rule limits.
  - Some countries implement progressive triggers with corresponding tighter measures; Czech Republic sets thresholds on the debt-to-GDP ratios, each involving larger fiscal adjustments if triggered.
  - Economic theory: fiscal reaction function involves a stronger primary balance (less deficit) when debt and associated risks rise.
  - Having a limited number of “debt brake” thresholds can reduce complexity and curb incentives for circumvention.

- Timeframe of correction
  - Many fiscal rules require corrective actions to be implemented within one and a half or two years (Finland, Spain) after the breach.
  - Some require action within three years (Grenada).
  - More stringent mechanisms may require remedial action to be included in the next budget (Slovak Republic: balanced budget in the following fiscal year if debt is three percentage points of GDP or less below the ceiling).
  - Finland bases assessment of noncompliance on performance in the current year, the previous year, or over the previous two years.
  - Returning to rule limits after the expiration of an escape clause may necessitate a longer adjustment horizon.

- Quantifying the magnitude of the correction
  - Some rules require restoring compliance for current deviations; others call for fully unwinding past cumulative deviations.
  - Switzerland: accumulates any deviation from budgeted expenditures in a notional account; government must take sufficient measures to bring expenditures within the limit in next three annual budgets if the negative balance exceeds 6 percent of expenditure.
  - Germany, Grenada, Jamaica: require corrective actions for cumulative deviations.
  - When determining magnitude, essential to mitigate procyclical effects and avoid excessive tightening during adverse conditions.
  - Adjustment measures can be:
    - Prespecified (e.g., Slovak Republic: freeze on public sector wages if debt exceeds 53 percent of GDP, further spending cuts if debt surpasses 55 percent of GDP).
    - Discretionary with process requirements (present fiscal plan and compliance report to parliament).
    - Expressed quantitatively (for example, an adjustment of 0.5 percentage points of GDP or magnitudes agreed upon by the European Commission in Poland) or qualitatively (formulating an adjustment plan in Switzerland or fiscal measures in Ecuador).
  - Several countries have preemptive triggers requiring stronger fiscal actions when debt exceeds certain thresholds before breaching anchor levels.

- Desirable properties and implementation guidance
  - Activation based on prespecified conditions (for example, when debt exceeds a preemptive threshold or when fiscal rules are breached).
  - Balance: prespecified mechanisms can reduce sovereign risks but risk procyclical spending cuts when triggered.
  - Mechanism should be enshrined in legislation (Fiscal Responsibility Law and Public Financial Management Law) outlining procedures and reporting requirements.
  - Governments’ corrective plans—incorporating concrete measures—should be regularly updated in the MTFF report and presented to parliament.
  - Pace of corrective adjustments should align with sovereign risks; faster adjustments may be warranted if debt sustainability risks are high.
  - Corrective mechanisms for subnational governments usually work better when enforced by the central government; for supranational rules, oversight should be by an institution responsible for ensuring implementation.

### Strengthening fiscal institutions and governance
- Core issues
  - Fiscal rules often fail because of inadequate supportive fiscal institutions: overly optimistic macro-fiscal forecasts, poor budgetary control, weak links to MTFFs, and lack of independent fiscal oversight.
  - Fiscal oversight (fiscal councils, parliamentary budget committees, auditor offices) plays a watchdog function: monitor compliance with fiscal rules and assess reliability of macroeconomic projections.

- Mandates, communication, and independence
  - Many fiscal councils, particularly in EMDEs, do not effectively communicate assessments to the public or publish reports regularly; published reports often lack assessment of forecasts or debt sustainability risks.
  - Some fiscal councils lack operational independence and may face budget shortfalls or political interference.
  - Fiscal councils should have direct communication with the media and have a well-defined mandate aligned with resources, budget safeguards, and timely access to information.
  - For small developing countries where a standalone fiscal council may be impractical, leverage existing entities (general audit office or parliamentary budget committee) to fulfill oversight functions.

- MTFF linkages
  - MTFF should be closely linked to fiscal rules and annual budgets; include fiscal strategy, medium-term macro fiscal projections, measures for achieving fiscal targets, and fiscal risks assessment.
  - MTFF report should be prepared and published before the budget and can include multiyear ceilings disaggregated into sector-specific or programmatic frameworks (examples cited: France, Rwanda, South Africa, Sweden).

- Empirical associations and quantitative findings
  - Strengthening fiscal rules and fiscal councils is associated with reduced deficit bias and stronger fiscal outcomes (empirical analysis using IMF Fiscal Rules and Fiscal Council databases; see Technical Annex 2).
  - Political discourse on fiscal restraint:
    - Countries with stronger fiscal rule frameworks or more effective fiscal councils experienced a smaller decline or even an increase in political restraint discourse, by about 0.7 percentage points, compared to countries without these mechanisms.
  - Forecast surprises and strength indices:
    - Surprises in primary deficits decline by 0.4 and 0.2 percentage point of GDP when the strength of fiscal rules improves from the 25th percentile to the 75th percentile.
    - A similar reduction in debt surprises averages 2 and 0.6 percentage points of GDP, respectively, with improvements in strength indices.
  - Compliance with debt rule limits:
    - An increase in the strength of debt rule from 25th to 75th percentile corresponds to a 6 percent reduction in deviations from debt rule limits.
    - More effective fiscal councils are associated with a decrease in excessive deviations from debt rule limits, averaging 1.5 percent of the country’s debt-to-GDP ratio.
  - Findings indicate stronger rules and councils correlate with smaller deficit and debt surprises and better compliance with fiscal rules.

### Should fiscal rules be revised to address spending pressures? Model-based assessment and simulation results
- Context and modeling approach
  - Structural spending pressures require trade-offs between priority expenditures and fiscal discipline.
  - A dynamic general equilibrium model (extending Traum and Yang (2015) and Mian, Straub, and Sufi (2022)) is employed to assess adjustments to fiscal rules to facilitate additional public investment.
  - Model features: public investment and public consumption, tax instruments, endogenous nonlinear debt distress risk increasing with debt-to-GDP.
  - Nonlinearity links to initial debt level and captures disproportionate rises in borrowing costs as debt increases; fiscal multipliers relate to debt distress risk and financing means.
  - Calibrations to three economies with distinct debt risk levels:
    - (1) advanced economy with low initial debt at 60 percent of GDP,
    - (2) country with limited fiscal space and high initial debt at 110 percent of GDP,
    - (3) advanced economy with very high debt at 140 percent of GDP.
  - Fiscal rules assumed binding at deficit or expenditure ceilings.
  - Households hold government bonds and require a risk premium for higher risks.
  - Simulations consider a 1 percentage point of GDP increase in public investment over a 10-year horizon.
  - Analysis focuses on first 15 years and assesses whether debt stabilizes or declines at the end of the horizon.

- Key simulation findings and policy implications
  - Excluding investment from rule limits
    - Excluding investment from fiscal rule limits leads to sharp and persistent increases in debt, especially for high-debt countries.
    - For high-debt countries with limited fiscal space, higher risk of debt distress is associated with lower output impact from additional investment.
    - Simulations indicate debt could rise by 15–24 percent of GDP over the next decade without stabilizing, which puts debt sustainability at risk.
    - Exclusions could incentivize misclassification of expenditures and complicate public debt management.
    - Conclusion: excluding capital expenditure from rules or activating the escape clause to provide flexibility for extended public investment is generally not advisable, as debt will continue to rise.

- Overarching implication
  - Adjustments to fiscal rules should carefully weigh how investment is financed, the initial debt level, the nonlinear risk of debt distress, and the potential for procyclical tightening or misclassification. Fiscal institutions, MTFFs, and independent oversight should be strengthened in tandem with any rule revisions to preserve sustainability and enable growth-enhancing spending where warranted.

*Source: Acalin, Martinez, and Roch (2025).*

### Appendix 3 ). This would suggest smaller initial debt levels for low or high debt for EMDEs.

### sdnea2025004 - Appendix 3 ). This would suggest smaller initial debt levels for low or high debt for EMDEs.

### Simulation setup and scenario framing
- Simulation framework: dynamic stochastic general equilibrium-based model.
- Investment shock modeled as:
  - 1 percentage point of GDP additional investment (from 4 percent of GDP to 5 percent of GDP).
  - Maintained for 10 years.
  - Cumulative cost of the public investment program is about 12 percent of GDP over 15 years, with the economy converging toward a path of balanced economic growth and stable debt-to-output ratios.
- Financing modalities considered:
  - Easing of fiscal rules on expenditure or deficit limits to finance investment (debt-financed).
  - Offsetting additional investment by cutting other government spending or raising revenues.
- Key model outputs reported: ex ante primary balance (percent of GDP deviation from baseline), probability of debt distress, debt-to-GDP ratio (percent), output (percent deviation from baseline), and cumulative fiscal multipliers over a 20-year horizon.
- Note on calibration of rules: The tightening of the rule limits after the investment program ends could be calibrated to offset the rise in debt-to-GDP ratio that would otherwise occur during the investment phase.

### Findings: Low-debt / ample fiscal space countries
- Main outcomes when easing fiscal rules modestly to accommodate investment:
  - Sustained output gains with manageable debt dynamics.
  - Endogenous fiscal multipliers are likely higher and positively correlated with the extent of debt-financed investment when debt level is low.
  - For advanced countries with debt of about 60 percent of GDP, modestly easing fiscal rules to allow additional investment would temporarily increase debt by 8–10 percentage points of GDP, which would eventually return to a downward path over the medium term.
  - Resulting investment contributes to higher output (with cumulative multipliers above 1.0).
  - Interest rates rise modestly as monetary policy tightens to maintain stable inflation; the interest-growth differential remains largely unchanged.
- Policy implication:
  - Countries with low debt can adjust rules within debt-stabilizing limits, provided additional investment aligns with capacity to maintain spending efficiency.
  - Practical adjustments include recalibrating deficit or expenditure limits and/or committing to a higher debt anchor.

### Findings: High-debt countries
- Main outcomes when relaxing fiscal rules to allow additional debt-financed investment:
  - Rising interest rates, weaker output effects, and unsustainable debt paths.
  - For advanced economies starting from a debt level of 110 or 140 percent of GDP, additional debt-financed investment would increase debt-to-GDP ratios by 12–24 percentage points; however, output gains are much more muted (with cumulative multipliers below 0.5).
  - Rising interest costs widen interest-growth differentials and lead to an unsustainable debt trajectory.
  - There is an inverse relationship between the degree of easing the rule and the multiplier for high-debt countries; the multiplier deteriorates more rapidly as the rule is relaxed further.
- Policy implication:
  - Easing fiscal rule limits to finance additional investment is not a viable option for high-debt countries.
  - Scaling-up investment or other priority spending must be offset through fiscal adjustments (e.g., raising taxes, reprioritizing expenditures, or enhancing spending efficiency).
  - Maintaining fiscal rule limits is crucial for preserving debt sustainability and supporting economic growth.

### Findings: Countries with limited fiscal space (intermediate/high debt)
- Two adjustment paces after initial scaling up of public investment were simulated:
  - Faster fiscal adjustment:
    - Makes rules more binding.
    - Necessitates cuts in current spending to contain debt, potentially resulting in abrupt reductions in primary spending.
  - Lengthening adjustment horizon:
    - May create space for investment but could heighten the risk of debt distress, especially with high debt levels.
- Example: The European Union’s fiscal framework permits a longer adjustment period (seven years instead of four) if member states use the additional room for growth-enhancing investment and reforms; the longer adjustment horizon is estimated to provide €700 billion in fiscal room between 2025 and 2031.
- Policy implication:
  - Any extension of adjustment horizons should ensure fiscal rules continue to guide policies aimed at maintaining debt sustainability.

### Fiscal rule adjustment options, merits, and risks
- Two illustrative options to accommodate investment:
  1. Temporary easing of fiscal rule limits to accommodate investment, followed by a tighter limit once the investment program ends.
     - Benefit: reduces scope for misclassifying spending and creative accounting.
     - Risk: easing could become permanent, potentially leading to rapid rise in debt if the investment program is extended.
  2. Temporary exclusion of the additional investment from fiscal rules, paired with immediate tightening of expenditure or deficit limits on nonpriority spending.
     - Benefit: allows immediate tightening of nonpriority spending.
     - Risk: creates opportunities for misclassification and political interference in prolonging investment programs; in countries lacking oversight or capacity, large risk of debt buildup without corresponding tighter adjustments in the future.
- Additional considerations:
  - Net expenditures should adhere to previously agreed commitments, and any permanent increases in fiscal outlays should be financed by mobilizing revenues.
  - Non-investment expenditures (pensions, healthcare) typically have lower fiscal multipliers than public investment; for the same size of additional spending, debt-to-GDP ratio will rise more due to lower output from smaller multipliers and endogenously higher interest rates.
  - Defense spending mixes current and capital expenditures and presents challenges for exclusion from rules.
  - Political economy and communication affect governments’ credibility; these are not modeled in the simulations.

### Policy recommendations and institutional measures
- Select a prudent fiscal anchor within a risk-based fiscal rule framework tailored to a country’s debt-carrying capacity to ensure sufficient fiscal buffers and mitigate sovereign distress risk.
- Design robust corrective mechanisms with predefined triggers, timelines, and corrective measures to guide return to fiscal rule limits; well-designed mechanisms can contribute to persistent reductions in sovereign spreads.
- Strengthen fiscal oversight:
  - Fiscal councils should establish direct communication channels with media through dedicated webpages, press events, and publications (fiscal risk reports, debt sustainability assessments, costing of fiscal policies).
  - Ensure operational independence of fiscal councils with clearly defined mandates aligned with resources, budgetary safeguards, timely access to public finance information at no cost, and significant media engagement.
- Preserve the integrity and transparency of fiscal rules:
  - Avoid excluding expenditures from fiscal rule limits across all countries to prevent misclassification incentives and debt buildup.
  - For countries with low debt and ample fiscal space: consider easing overly tight fiscal rules within debt-stabilizing limits to facilitate gradual increase in public investment.
  - For countries with limited or no fiscal space: prioritize preserving debt sustainability and rebuilding fiscal buffers; scaling-up growth-enhancing investment requires offsetting measures while maintaining rule integrity.
- Improve expenditure prioritization and efficiency:
  - Regular reviews of expenditures against established priorities to uncover efficiency gains and create space for public investment.
  - Strengthen public investment management frameworks covering planning, resource allocation, and implementation to enhance investment efficiency within fiscal rules.

### Key statistics and calibration points from the text
- Investment shock: 1 percentage point of GDP (from 4 percent of GDP to 5 percent of GDP) for 10 years.
- Cumulative cost of public investment program: about 12 percent of GDP over 15 years.
- Advanced countries reference debt level: about 60 percent of GDP; easing rules could temporarily increase debt by 8–10 percentage points of GDP.
- High-debt advanced economy reference debt levels: 110 or 140 percent of GDP; additional debt-financed investment could increase debt-to-GDP ratios by 12–24 percentage points; cumulative multipliers below 0.5.
- EU adjustment example: lengthening adjustment horizon from four years to seven years estimated to provide €700 billion in fiscal room between 2025 and 2031.
- Institutional adoption statistic: As of the end of 2024, more than 120 economies and 50 countries have adopted fiscal rules and established fiscal councils.

*Source: STAFF DISCUSSION NOTES — Fiscal Guardrails against Rising Debt and Looming Spending Pressures, INTERNATIONAL MONETARY FUND.*

### References

### References

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### Sovereign risk, sovereign spreads, and debt dynamics
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### Public investment, long-term spending pressures, and investment protection
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### Methodology, econometrics, and measures of uncertainty
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### IMF and international institutional reports and policy papers
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### Political economy, discretionary policy, and macro-fiscal interactions
- Azzimonti, Marina, Marco Battaglini, and Stephen Coate. 2016. “The Costs and Benefits of Balanced Budget Rules: Lessons from a Political Economy Model of Fiscal Policy.” Journal of Public Economics 136: 45–61.
- Debrun, Xavier, and Tidiane Kinda. 2014. “Strengthening Post-Crisis Fiscal Credibility: Fiscal Councils on the Rise – A New Dataset.” IMF Working Paper No. 2014/058, International Monetary Fund, Washington, DC.
- Dovis, Alessandro, and Rishabh Kirpalani. 2020. “Fiscal Rules, Bailouts, and Reputation in Federal Governments.” American Economic Review 110 (3): 860–88.
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### Databases, country cases, and regional analyses
- European Commission. 2024. Numerical Fiscal Rules database – 2024 update. https://economy-finance.ec.europa.eu/economic-research-and-databases/economic-databases/fiscal-governance-database_en#independent-fiscal-institutions
- New Zealand Treasury. 2015. “An Introduction to New Zealand’s Fiscal Policy Framework.” Wellington.
- New Zealand Treasury. 2019. “A Guide to the Public Finance Act.” Wellington.
- Organisation of Economic Cooperation and Development. 2021. “2021 OECD Independent Fiscal Institutions Database”, OECD 2021.
- Eyraud, Luc, Vitor Gaspar, and Tigran Poghosyan. 2017. “Fiscal Politics in the Euro Area.” IMF Working Paper No. 2017/018, International Monetary Fund, Washington, DC.
- Burriel, Pablo, Cristina Checherita-Westphal, Pascal Jacquinot, Matthias Schön, and Nikolai Stähler. 2020. “Economic Consequences of High Public Debt: Evidence from Three Large Scale DSGE Models.” ECB Working Paper No. 2450, European Central Bank, Frankfurt.

*References list from "Fiscal Guardrails against High Debt and Looming Spending Pressures" Staff Discussion Note No. SDN/2025/004*

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_Source: https://www.imf.org/-/media/files/publications/sdn/2025/english/sdnea2025004.pdf_