## Executive Summary

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---

### Overview and purpose
- The paper assesses the usefulness of fiscal rules in supporting fiscal consolidation, discusses the design and implementation of rules based on a new data base spanning the whole Fund membership, and explores the fiscal framework that could be adopted as countries emerge from the crisis.
- The sharp increase in fiscal deficits and public debt in most advanced and several developing economies has raised concerns about the sustainability of public finances and highlighted the need for a significant adjustment over the medium term.
- The credibility of the needed fiscal adjustment will be essential to anchor longer-run expectations about government solvency.

### Definition of fiscal rules
- A fiscal rule is defined as "a permanent constraint on fiscal policy through simple numerical limits on budgetary aggregates (Kopits and Symansky, 1998)."
- Key elements:
  - a numerical target over a long-lasting time period to guide fiscal policy;
  - a summary operational fiscal indicator to which it is applicable;
  - simplicity to permit ready operationalization, communication to the public, and monitoring.
- Note: some institutional arrangements closely resemble rules and constitute “gray” areas (e.g., institutional fiscal frameworks that use numerical targets that are subject to revision).

### Trends and prevalence
- Fiscal rules have become more common in recent years.
- Historical snapshots:
  - In early 2009, 80 countries had in place national or supranational fiscal rules.
  - In 1990, only seven countries had fiscal rules.
  - In 2009, 53 countries had national fiscal rules in place (of which 20 had them in combination with supranational rules).
  - About 52 percent of the rules in operation were national rules; the remainder were embodied in four supranational treaties: the SGP in Europe; WAEMU; CEMAC; and ECCU.
- The recent crisis strained rules: about a quarter of the countries with national rules modified them or put them into abeyance.

### Association with fiscal performance
- Use of fiscal rules is on average associated with improved fiscal performance.
- Caution: the association may reflect changes in countries’ attitudes toward fiscal rectitude that determine both improved fiscal performance and introduction of rules.
- Empirical pattern: rules are often introduced to lock-in earlier consolidation efforts rather than at the beginning of fiscal adjustment.
- Alternative: transparent and credible strategies backed by proper fiscal institutions can also support fiscal discipline.

### Objectives and types of rules (comparative properties)
- Rules can serve different goals; primary focus here is promoting fiscal sustainability.
- Types and salient properties:
  - Budget balance rules: overall balance, structural or cyclically adjusted balance, and balance “over the cycle” can help ensure that the debt-to-GDP ratio converges to a finite level.
  - Primary balance rules: less linked to debt sustainability because increases in interest payments would not require an adjustment even if they affect the budget balance and public debt.
  - Golden rule (overall balance net of capital expenditures): even less linked to debt.
  - Debt rules: set an explicit limit or target for public debt in percent of GDP; most effective in ensuring convergence to a debt target but provide limited guidance when debt is well below the ceiling.
  - Expenditure rules: permanent limits on total, primary, or current spending in absolute terms, growth rates, or percent of GDP; operational tools when accompanied by debt or budget balance rules.
  - Revenue rules: ceilings or floors on revenues aimed at boosting revenue collection and/or preventing excessive tax burden; not directly linked to control of public debt as they do not constrain spending.
- Rules’ responses to shocks:
  - Overall balance or debt rules typically provide the lowest degree of cyclical flexibility.
  - Cyclically adjusted or structural balance rules allow the full operation of automatic stabilizers, though not room for discretionary fiscal stimulus.
  - “Over the cycle” rules provide room for both discretionary and cyclical adjustments.
  - Expenditure rules permit cyclical and discretionary reductions in tax revenues but do not normally permit discretionary expenditure stimulus.
  - Revenue rules tend to result in procyclical fiscal policy because automatic stabilizers are stronger on the revenue side.

### Design and implementation considerations (high-level findings)
- A rule must be credible in its ability to deliver required adjustment and put debt on a sustainable path, while having adequate flexibility to respond to shocks.
- Simulation analysis shows cyclically adjusted balance rules are superior in dealing with output shocks, but cyclical adjustment requires care (measurement and implementation challenges).
- Key design issues:
  - Appropriate variable to constrain (overall balance, primary balance, structural/cyclically adjusted balance, expenditure, revenue, debt).
  - Response to output shocks (cyclical flexibility versus strict numerical limits).
  - Response to inflation, interest rate and exchange rate shocks (impact on debt service and budget).
  - Treatment of other shocks and one-off factors under structural balance rules.
  - Response to past deviations (how rules should treat past noncompliance).
  - Appropriate coverage (general government versus parts of government; treatment of capital spending; exemptions).
  - Timing of introduction (rules often lock-in consolidation rather than initiating it).
  - Legislative support and statutory basis (rules embedded within fiscal responsibility laws (FRLs) are more difficult to reverse but can take longer to establish).
  - Enforcement mechanisms, monitoring, and effective accountability procedures are important determinants of effectiveness.

### Crisis and transition guidance
- Crisis experience:
  - About a quarter of countries with national rules modified them or put them into abeyance during the recent crisis.
- Transition-period guidance when large consolidation needs and unusual uncertainty prevail:
  - Early implementation of a new rule or a rapid return to fiscal targets implied by an existing rule may not be appropriate because required speed of adjustment may be excessive.
  - During the transition, a parametric approach focused on medium-term targets is preferable.
  - It may be helpful to design and announce early-on a credible rule-based framework and a timetable for its implementation or for a return to the existing rule-based path.
- Sequencing recommendation:
  - A time-bound, realistic consolidation plan should precede the implementation of the rule in countries with large consolidation needs and high uncertainty.
  - During the transition, clearly specified multiyear structural balance paths backed by appropriate benchmarks and policies are instrumental.

### Institutional and policy context
- Fiscal rules embedded within stronger legal frameworks, including FRLs, tend to be more durable.
- Complementary approaches include transparent fiscal strategies and proper fiscal institutions (monitoring, accountability, independent agencies) that can substitute for or reinforce numerical rules.

### Dataset, global coverage, and index construction
- Dataset covers 80 advanced, emerging, and low-income economies and includes national (but not subnational) and supranational rules.
- In early 2009:
  - 80 countries with national and/or supranational fiscal rules: 21 advanced, 33 emerging markets, and 26 low-income countries.
  - Average number of numerical rules per country: Early 1990s: 1½; By early 2009: almost 2½.
  - About 60 percent of countries with rules had a budget balance rule; about 60 percent had a debt rule.
  - Some variant of cyclically adjusted and structural balance targets used by about 11 percent of the countries.
  - An over-the-cycle fiscal rule adopted only by the United Kingdom and Sweden (and in the U.K. the financial crisis led to its abeyance).
- Index of strength of fiscal rules:
  - Constructed using principal component analysis of variables: enforcement score; coverage score; legal basis score; supranational rules score; supporting procedures index; flexibility score; average number of fiscal rules; ratio of national to total fiscal rules.
  - The index retains more than 80 percent of the original data variance and is standardized to have a zero mean and a standard deviation of one.
- Evolution notes:
  - Enforcement procedures and flexibility (cyclically adjusted balances) became more widespread.
  - Statutory basis and monitoring procedures have not become more widespread, particularly in low-income countries.
  - Legal-basis index has slightly declined over time due to adoption of additional, more informal rules.

### Preconditions and complementary Public Financial Management (PFM) reforms
- Preconditions for effective implementation:
  - Reliable data availability and minimum technical forecasting capacity.
  - Comprehensive budget reporting systems producing in-year and timely end-year reports.
  - Internal and external audit systems.
  - Fiscal data consistent with budget reporting and publicly released in line with a pre-announced calendar.
- Broader reforms commonly accompanying rules:
  - Legislated broad principles guiding fiscal policy formulation.
  - Rolling budget plans and fiscal projections over short, medium, and long horizons.
  - Effective budget mechanisms to minimize deficit biases (top-down budgeting, cost-benefit analysis, program budgeting).
  - Strong transparency requirements and public oversight (mandatory publication of regular reports with multiyear fiscal projections).

### Independent fiscal agencies / fiscal councils
- Roles:
  - Provide objective analysis of fiscal developments and costing of budgetary initiatives.
  - Produce independent projections and forecasts of budgetary and macroeconomic variables.
  - Provide normative assessments regarding appropriateness of fiscal stance (in some cases).
- Prevalence examples:
  - Share of countries with independent fiscal bodies assessing the budget: 18 percent in advanced economies; 2 percent in developing countries.
- Country examples:
  - Chile: projection inputs for trend GDP and “trend” copper prices delegated to two independent expert panels.
  - Netherlands: Central Planning Bureau (CPB) provides economic assumptions for the budget.
  - Hungary: “Fiscal Council” monitors compliance with a new rule from the Fiscal Responsibility Law (November 2008) and provides independent forecasts (not binding).
  - Sweden: Fiscal Policy Council monitors compliance with the surplus target of 1 percent of GDP on average over the business cycle.
  - U.S.: Congressional Budget Office (CBO) advises Congress and “scores” legislative proposals.

### Fiscal responsibility laws (selected country features)
- FRL examples and features (selected):
  - Argentina: Federal Regime of Fiscal Responsibility (2004) — Procedural Rules: Yes; Numerical Targets in FRL: ER; DRCG; Escape Clauses: Yes; Sanctions: Yes.
  - Australia: Charter of Budget Honesty (1998) — Procedural Rules: Yes; Numerical Targets in FRL: -- 5/; Coverage: CG; Escape Clauses: No; Sanctions: No.
  - Brazil: Fiscal Responsibility Law (2000) — Procedural Rules: Yes; Numerical Targets in FRL: -- 5/; Coverage: PS; Escape Clauses: Yes; Sanctions: Yes.
  - India: Fiscal Responsibility and Budget Management Act (2003) — Procedural Rules: Yes; Numerical Targets in FRL: BBR; Coverage: CG; Escape Clauses: Yes; Sanctions: No.
  - Spain: Budget Stability Law (2007) — Procedural Rules: Yes; Numerical Targets in FRL: BBR; Coverage: NFPS; Escape Clauses: Yes; Sanctions: Yes.
  - United Kingdom: Code for Fiscal Stability (1998) — Procedural Rules: Yes; Numerical Targets in FRL: -- 5/; Coverage: PS; Escape Clauses: No; Sanctions: No.
- Legend: ER = Expenditure rule; BBR = Budget balance rule; DR = Debt rule; RR = Revenue rule. Coverage codes: CG = Central government; GG = General government; PS = Public sector; NFPS = Non-financial public sector.

### Pros and cons of fiscal rules (effects on policymaking)
- Rationale:
  - Aim to correct deficit bias caused by shortsightedness and the “common pool problem.”
  - In currency unions, supranational rules internalize regional costs of fiscal indiscipline and aid monetary-fiscal coordination.
- Concerns:
  - Rules without political commitment or prerequisites may not be sustained and could undermine credibility.
  - Deficit and debt ceilings may induce procyclical stances in bad times and be nonbinding in good times.
  - Rules often silent on composition of adjustment, risking cuts to high social-return capital spending.
  - Rules can divert political capital from structural reforms.
  - Rules may encourage “creative” accounting and off-budget operations, reducing transparency.

### Empirical findings on fiscal rules and performance
- EU countries: tighter and more encompassing fiscal rules correlated with stronger cyclically adjusted primary balances; relation weakens when measuring changes in public debt-to-GDP ratios.
- By rule type:
  - Budget balance and debt rules contributed to better budgetary outcomes.
  - Expenditure rules impact found mainly in restraining primary spending.
- Government level matters: rules for higher levels of government associated with more fiscal discipline than those applying to local governments.
- Design features associated with better performance include strong legal basis and strict enforcement.
- Credibility and market premia:
  - A direct “credibility reward” is reaped primarily by countries that had already pursued reasonably prudent policies.
  - In OECD countries, the size of fiscal consolidations was significantly larger when national or supranational fiscal rules were present.
  - For EU countries, stronger and wider fiscal rules were associated with a greater likelihood for successful fiscal consolidation.

### New evidence on fiscal rules and large adjustments
- Review: 24 episodes in G-20, OECD, and EU member states since 1980 (sample excludes oil exporters and episodes driven mainly by rapid real GDP growth and inflation in some analyses).
- Average outcomes in these large-adjustment episodes:
  - Countries in the sample managed to reduce their public debt ratios on average by 27 percent of GDP (or 40 percent of the initial debt ratio) over a period of about seven years.
- Comparative findings (Table 3 excerpts preserve source ordering):
  - Initial public debt: 48.5 69.7 70.3 68.8
  - Reduction in public debt: 20.3 29.7 24.0 38.5
  - Relative reduction in debt (percent of initial public debt ratio): 42.6 42.9 33.1 58.2
  - Adjustment length (years): 6.3 8.2 7.1 10.0
  - Annual reduction in public debt: 4.0 3.7 3.3 4.3
  - Front-loading of reduction in public debt ratio (percent) 1/: 49.5 39.1 40.0 44.0
  - Front-loading of adjustment in CAPB (percent) 3/: 1.3 9.6 40.0 0.1
  - Memorandum item: Number of countries: 6 18 11 7
- Role of rules in large adjusters:
  - Combining budget balance with expenditure rules appears particularly effective.
  - Rules in large adjusters tended to have wide coverage and stronger monitoring/enforcement mechanisms.

### Determinants of fiscal-rule adoption (econometric findings)
- Sample: 68 economies (OECD + emerging market economies in the EMBIG Index) over 1985–2008; separate analysis sample includes 22 OECD countries for 1990–2008.
- Univariate/bivariate hazard results:
  - Countries with a larger primary surplus had a 40 percent higher probability of adopting a rule.
  - Countries with a ratio of public debt to GDP below the sample average had three times the chance to adopt a rule.
  - High inflation and currency depreciations associated with lower probabilities of introducing a fiscal rule.
  - Positive GDP growth and higher reserves to GDP increased likelihood of adopting a rule.
- Multivariate results:
  - Good fiscal performance positively affects both likelihood of having fiscal rules and average number of quantitative fiscal targets.
  - Poor initial fiscal conditions delay introduction of fiscal rules.
  - Relationship with public debt is nonlinear: a threshold estimated in the range of 80 percent to 100 percent of GDP.
  - Exchange rate stability, low public debt, and price stability increase likelihood of certain rules.
  - Presence of supranational fiscal rules increases the number of fiscal targets; federal states tend to have wider coverage of rules.

### Credibility effects and market risk premia
- OECD finding (1990–2008):
  - OECD countries with public debt ratios below 70 percent of GDP experienced a reduction in 10-year bond spreads by 10–20 basis points in the long run, depending on statutory rank and quality of monitoring and enforcement.
  - In a full sample of OECD economies, the presence of a fiscal rule did not affect spreads once macroeconomic and fiscal conditions were controlled for.
- Cyclical contingency:
  - Eight OECD countries operate frameworks that explicitly allow for countercyclical fiscal policy in some form.
  - Estimates suggest a moderate strengthening of fiscal rules accompanied by introduction of a cyclicality contingency can lower spreads by 10 basis points upon impact, and up to 20 basis points in the long run.

### Implementing a structural balance rule — three required elements
- First, a structural balance target:
  - Definition: the balance that would lead to a sustainable debt level; should account for expected increases in spending due to demographic and other factors.
  - Example: structural surplus objectives in Denmark and Finland account explicitly for rising age-related spending.
- Second, an estimation of the output gap:
  - Methods: simple statistical procedure (Hodrick-Prescott (HP) filter) or production function approach; HP filter subject to end-point bias and sensitivity parameter issues.
- Third, estimates of revenue and expenditure elasticities:
  - Based on past relationships between the budget and the output gap; revenue elasticities tend to be higher than expenditure elasticities.
  - Challenges: cycles in corporate profits and asset prices may not be captured by output changes.

### Structural-balance rule variants and responses (Box 4)
- Basic structural balance rule (formal):
  - b_t = b* + a y_t^G , a>0
    - b_t: overall balance in the current year
    - b*: medium-term balance target
    - a: semi-elasticity of budget balance with respect to the output gap
    - y_t^G: output gap in the current year
- Growth-based balance variant:
  - b_t = b* + a (g_t - g*) , a>0
    - g_t: GDP growth rate in the current year
    - g*: average long-run GDP growth rate
  - Note: could give rise to a procyclical response.
- Augmented structural balance rule (responding to past deviations):
  - b_t = b* + a y_t^G - c (b_{t-1} - b*) , a>0 , 0<c<1
    - c: pace of correction to previous-year deviation.
- Augmented growth-based balance rule:
  - b_t = b* + a (g_t - g*) + e (b_{t-1} - b*) , a>0 , 0<e<1
    - e: pace of adjustment when previous-year balance is away from b*.

### Responses to inflation, interest-rate and exchange-rate shocks
- Inflation:
  - Nominal balance, expenditure, and revenue ceilings most affected.
  - Real-term budget aggregate ceilings protect from inflation effects.
  - Consider inflation-adjusted fiscal target to eliminate inflationary component of debt service when appropriate.
- Interest-rate and exchange-rate shocks:
  - Targeting the primary balance may be helpful when shocks are transitory but frequent.
  - Exceptional circumstances clause recommended for rare large shocks, with strict triggering criteria and clear path back to the rule.

### Coverage issues and trade-offs
- Two coverage questions:
  - Level of government the rule applies to (central, subnational, social security, public companies).
  - Items included in the target variable (interest payments, cyclically-sensitive expenditure, capital expenditure).
- Selective coverage trade-offs:
  - Interest payments:
    - Excluding: not under short-run control; volatile.
    - Including: compatible with objectives for overall public debt.
  - Capital expenditure:
    - Excluding: politically easier; risks reclassification and weakens debt link.
    - Including: compatible with debt objectives; more transparent.
  - Golden-rule risks: exclusion of capital expenditure may risk negative long-run growth impacts if capital spending is cut.

### Coverage for primary commodity exporters (Box 6)
- Targeting a noncommodity fiscal balance:
  - Advantages: insulates budget from commodity revenue volatility; permits stable expenditures; may support intergenerational equity.
  - Risks: a steep decline in commodity revenues could lead to a large increase in the overall deficit with a given noncommodity balance.
- Suggested safeguards:
  - Complement noncommodity deficit target with a limit on cumulative deviation of overall deficit from its notional target over a rolling period; require corrective measures if exceeded (analogous to Swiss “debt brake”).
  - Alternative: structural-balance approach correcting for commodity price deviations from long-term levels (example: Chile).
- Net versus gross debt:
  - Net debt desirable in principle, but gross debt indicators are generally used in fiscal rule frameworks.

### Simulation findings (Appendix III) — comparative performance of rule variants
- Simulated rule variants:
  - (i) Basic structural balance rule.
  - (ii) Augmented growth-based rule.
  - (iii) Augmented structural balance rule.
- Summary of simulation conclusions:
  - Cyclically adjusted balance rules combined with mechanisms to correct past deviations are best suited to achieve significant debt reduction while preserving room for countercyclical fiscal policy.
  - Under a large shock:
    - All rules narrow the budget deficit after the initial shock at different speeds.
    - Augmented growth-based rule leads to fastest reduction in debt in the large shock scenario.
    - Augmented structural balance and augmented growth-based rules provide room for countercyclical responses while incorporating correction mechanisms consistent with debt sustainability.
  - In a low-growth scenario:
    - Augmented growth-based rule ensures debt consolidation; basic structural balance rule could place debt-to-GDP on an unsustainable path.
  - In boom-bust and contingent liability scenarios:
    - Augmented structural balance rules reduce fiscal balance fluctuations better than the basic structural rule.
    - All rules behave similarly in case of a sudden increase in debt from contingent fiscal risks.
- Simulation scenarios (assumed real GDP growth rates):
  - Baseline: 1.5, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0
  - Large shock: 1.5, 4.0, -3.0, 0.5, 2.0, 7.0, 7.0, 6.0, 5.0, 4.5, 4.5
  - Low growth: 1.5, 4.0, 3.0, 3.0, 3.0, 3.0, 3.0, 3.1, 3.2, 3.3, 3.4
  - Fiscal risk: 1.5, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0
  - Boom-bust: 1.5, 4.0, 7.0, 7.0, 7.0, 7.0, -5.0, 0.0, 3.0, 4.0, 4.5
  - Memorandum item: Commodity price index: 100, 104, 107, 110, 103, 99, 96, 95, 96, 97, 97

### Practical aspects of calculating structural balances
- Output gap estimation:
  - HP filter: objective and reproducible; subject to end-point bias and sensitivity to cycle duration; mitigate end-point bias using reasonable forecasts.
  - Production function approach: based on fundamentals; more data demanding.
- Elasticities:
  - Revenue elasticities tend to be higher than expenditure elasticities; elasticities can change over time and should be estimated disaggregated by tax base and expenditure type.
- Fiscal sustainability technical notes:
  - Notation: tp = primary balance-to-GDP ratio; td = debt-to-GDP ratio.
  - Growth-adjusted interest rate λ defined by λ = (1 + i)/(1 + γ) − 1.
  - Intertemporal budget constraint, no-Ponzi game condition, and recursive identities summarized in Appendix IVb.

### Policy recommendations and sequencing
- For countries with small adjustment needs and no existing rule:
  - Introducing a well-designed and implemented rule supported by political commitment and institutional mechanisms can guide fiscal policy and anchor expectations.
- For countries with large consolidation needs and high uncertainty:
  - Early implementation of a rule targeting immediate fiscal targets may be infeasible; adopt a time-bound consolidation plan first.
  - Design and announce a credible rule-based framework and timetable for implementation while pursuing a realistic transition path.
- General guidance:
  - Ensure credibility through statutory basis, monitoring, enforcement, and supporting institutions (PFM reforms, independent fiscal bodies).
  - Use cyclically adjusted or structural balance rules with correction mechanisms to balance flexibility and debt sustainability.
  - For commodity exporters, consider noncommodity balance targets with safeguards or commodity-adjusted structural balance rules.

*Source: Executive Summary and Sections I–II of the IMF paper (as provided in the supplied content).*

### Executive Summary ......................................................................................................

### Executive Summary

### Overview and purpose
- The paper assesses the usefulness of fiscal rules in supporting fiscal consolidation, discusses the design and implementation of rules based on a new data base spanning the whole Fund membership, and explores the fiscal framework that could be adopted as countries emerge from the crisis.
- The sharp increase in fiscal deficits and public debt in most advanced and several developing economies has raised concerns about the sustainability of public finances and highlighted the need for a significant adjustment over the medium term.
- The credibility of the needed fiscal adjustment will be essential to anchor longer-run expectations about government solvency.

### Definition of fiscal rules
- A fiscal rule is defined as "a permanent constraint on fiscal policy through simple numerical limits on budgetary aggregates (Kopits and Symansky, 1998)."
- Key elements of the definition:
  - a numerical target over a long-lasting time period to guide fiscal policy;
  - a summary operational fiscal indicator to which it is applicable;
  - simplicity to permit ready operationalization, communication to the public, and monitoring.
- Note: the designation of a fiscal rule may not always be straightforward; some institutional arrangements closely resemble rules and constitute “gray” areas (e.g., institutional fiscal frameworks that use numerical targets that are subject to revision).

### Trends and prevalence
- Fiscal rules have become more common in recent years.
- Historical context: rules existed in a few countries in the mid-nineteenth century at subnational level; post-World War II incorporation of budget balance rules in Germany, Italy, Japan, and the Netherlands; U.S. Gramm-Rudman-Hollings Act of 1985 (replaced by the Budget Enforcement Act of 1990); Canada’s Federal Spending Control Act of 1991; various Latin American adoptions in the late 1990s; EU supranational rules via the Maastricht Treaty (1992) and Stability and Growth Pact (1997).
- In early 2009, 80 countries had in place national or supranational fiscal rules.
- The recent crisis strained fiscal rules: about a quarter of the countries with national rules modified them or put them into abeyance.

### Association with fiscal performance
- The use of fiscal rules is on average associated with improved fiscal performance.
- Caution: the association may reflect changes in countries’ attitudes toward fiscal rectitude that determine both improved fiscal performance and introduction of rules.
- Empirical pattern: rules are often introduced to lock-in earlier consolidation efforts rather than at the beginning of fiscal adjustment.
- Alternative frameworks: fiscal frameworks not involving formal rules but focused on transparent and credible strategies backed by proper fiscal institutions could also provide a viable approach to support fiscal discipline.

### Objectives and types of rules (summary of comparative properties)
- Rules can serve different goals, with a primary focus here on promoting fiscal sustainability.
- Summary properties (as presented in Table 1):
  - Budget balance rules: overall balance, structural or cyclically adjusted balance, and balance “over the cycle” can help ensure that the debt-to-GDP ratio converges to a finite level.
  - Primary balance rules: less linked to debt sustainability because increases in interest payments would not require an adjustment even if they affect the budget balance and public debt.
  - The “golden rule” (overall balance net of capital expenditures) is even less linked to debt.
  - Debt rules: set an explicit limit or target for public debt in percent of GDP; by definition most effective in ensuring convergence to a debt target but provide limited guidance when debt is well below the ceiling.
  - Expenditure rules: permanent limits on total, primary, or current spending in absolute terms, growth rates, or percent of GDP; not directly linked to debt sustainability since they do not constrain revenue, but can be operational tools when accompanied by debt or budget balance rules.
  - Revenue rules: ceilings or floors on revenues aimed at boosting revenue collection and/or preventing excessive tax burden; not directly linked to control of public debt as they do not constrain spending.
- Rules’ responses to shocks:
  - Overall balance or debt rules typically provide the lowest degree of cyclical flexibility.
  - A cyclically adjusted or structural balance rule allows the full operation of automatic stabilizers, though it does not provide room for discretionary fiscal stimulus.
  - “Over the cycle” rules provide room for both discretionary and cyclical adjustments.
  - Expenditure rules permit cyclical and discretionary reductions in tax revenues but do not normally permit discretionary expenditure stimulus.
  - Revenue rules tend to result in procyclical fiscal policy because automatic stabilizers are stronger on the revenue side.
- Table 1 (Objectives summary) uses positive signs (+), negative signs (-), and zeros (0) to indicate relative strengths/weaknesses with respect to Debt sustainability, Economic stabilization, and Government size. (Exact sign patterns are presented in the source Table 1.)

### Design and implementation considerations (high-level findings)
- A rule must be credible in its ability to deliver the required adjustment and put debt on a sustainable path, while having adequate flexibility to respond to shocks.
- Simulation analysis shows that cyclically adjusted balance rules are superior in dealing with output shocks, but cyclical adjustment requires care (e.g., measurement and implementation challenges).
- Key design issues discussed include:
  - Appropriate variable to constrain (overall balance, primary balance, structural/cyclically adjusted balance, expenditure, revenue, debt).
  - Response to output shocks (cyclical flexibility versus strict numerical limits).
  - Response to inflation, interest rate and exchange rate shocks (impact on debt service and budget).
  - Dealing with other shocks and one-off factors (treatment under structural balance rules).
  - Response to past deviations (how rules should treat past noncompliance).
  - Appropriate coverage (general government versus parts of government; treatment of capital spending; exemptions).
  - Timing of introduction (rules often lock-in consolidation rather than initiating it).
  - Legislative support and statutory basis (rules embedded within stronger legal frameworks, including fiscal responsibility laws (FRLs), are more difficult to reverse but can take longer to establish).
  - Enforcement mechanisms, monitoring, and effective accountability procedures are important determinants of rules’ effectiveness.

### Crisis and transition guidance
- The recent crisis strained rules: about a quarter of countries with national rules modified them or put them into abeyance.
- In the transition period after the crisis, when large consolidation needs and unusual uncertainty prevail:
  - An early implementation of a new rule or a rapid return to fiscal targets implied by an existing rule may not be appropriate because the required speed of adjustment may be excessive.
  - During the transition period, a parametric approach focused on medium-term targets is preferable.
  - It may be helpful to design and announce early-on a credible rule-based framework and a timetable for its implementation or for a return to the existing rule-based path.

### Institutional and policy context
- Fiscal rules can be embedded within broader institutional frameworks; fiscal rules embedded within stronger legal frameworks, including FRLs, tend to be more durable.
- Important complementary approaches include transparent fiscal strategies and proper fiscal institutions (e.g., monitoring, accountability, independent agencies) that can substitute for or reinforce numerical rules.

*Source: Executive Summary and Sections I–II of the IMF paper (as provided in the supplied content).*

### 10.      In recent years, an increasing number of countries have relied on rules to guide

### 10.      In recent years, an increasing number of countries have relied on rules to guide policy

### Overview of adoption and prevalence
- In early 2009, there were 80 countries with national and/or supranational fiscal rules: 21 advanced, 33 emerging markets, and 26 low-income countries.
- In 1990, only seven countries had fiscal rules.
- In 2009, 53 countries had national fiscal rules in place (of which 20 had them in combination with supranational rules).
- About 52 percent of the rules in operation were national rules; the remainder were embodied in four supranational treaties: the SGP in Europe; the West African Economic and Monetary Union (WAEMU); the Central African Economic and Monetary Community (CEMAC); and the Eastern Caribbean Currency Union (ECCU).

### Dataset (Box 1) — scope and index construction
- Dataset coverage:
  - Covers 80 advanced, emerging, and low-income economies.
  - Includes national (but not subnational) and supranational rules.
  - Compiled from IMF area departments’ questionnaire responses and assessment of fiscal framework legislations.
- Dimensions covered:
  - (i) legal origin of rules, numerical target and year of adoption or major changes;
  - (ii) coverage of fiscal aggregates;
  - (iii) degree of freedom rules allow to policymakers in responding to shocks (e.g., cyclically adjusted targets, exclusions, escape clauses);
  - (iv) supporting procedures (monitoring of compliance outside government, independent fiscal assumptions, formal enforcement).
- Index of strength of fiscal rules:
  - Constructed using principal component analysis of variables: (i) enforcement score; (ii) coverage score; (iii) legal basis score; (iv) supranational rules score; (v) index of supporting procedures for monitoring of compliance and enforcement; (vi) flexibility score; (vii) average number of fiscal rules; (viii) ratio of national to total fiscal rules in each country.
  - The index retains more than 80 percent of the original data variance.
  - The index is standardized to have a zero mean and a standard deviation of one.

### Trends in types and combinations of rules
- Average number of numerical rules per country:
  - Early 1990s: 1½ numerical rules on average.
  - By early 2009: almost 2½ numerical rules on average.
- In early 2009:
  - About 60 percent of countries with fiscal rules had a budget balance rule.
  - About 60 percent had a debt rule.
  - Supranational rules often combine budget balance rules with debt rules (in 41 countries).
- Expenditure rules:
  - 1999: 10 countries with expenditure rules (about a fifth of the countries with rules at that time).
  - 2009: 25 countries with expenditure rules (almost a third of the countries with rules).
  - Combination of expenditure rules with budget balance or debt rules in 16 countries.
- Cyclically adjusted and structural balance targets:
  - Some variant is used by about 11 percent of the countries.
  - An over-the-cycle fiscal rule adopted only by the United Kingdom and Sweden (and in the U.K. the financial crisis led to its abeyance).

### Differences across country groups and rule features (2009)
- Flexibility:
  - More than a quarter of advanced economies have cyclically adjusted balances.
  - 10 percent of emerging economies have cyclically adjusted balances.
  - No low-income country has cyclically adjusted balances.
- Coverage:
  - Emerging markets: majority have targets expressed in terms of general government aggregates.
- Exclusions:
  - In low-income countries, rules frequently exclude public investment and other poverty-reduction spending aggregates (in more than 30 percent of the countries).
- Fiscal responsibility laws and enforcement:
  - Fiscal responsibility laws accompany rules in: more than a third of emerging economies; a fifth of advanced economies; a tenth of low-income countries.
  - Enforcement procedures and presence of fiscal responsibility legislation are more prevalent in emerging economies.
- Independent fiscal bodies:
  - Share of countries with independent fiscal bodies assessing the budget: 18 percent in advanced economies; 2 percent in developing countries.

### Evolution of rule stringency and features (2009 and over time)
- Overall strength:
  - The rules’ overall strength, measured by the composite index, has increased over the past decade.
- Components that became more widespread:
  - Enforcement procedures have become more widespread.
  - Flexibility of fiscal targets relative to output shocks (such as cyclically adjusted balances) has become more widespread.
- Components not common to all groups:
  - Statutory basis and monitoring procedures have not become more widespread, particularly in low-income countries.
- Note on legal-basis index:
  - An index measuring the strength of the legal basis (constitutional highest; informal coalition agreements lowest) shows balance and debt rules have much larger scores compared to expenditure and revenue rules.
  - The legal-basis index has slightly declined over time due to adoption of additional, more informal rules in the last decade.

### Preconditions and complementary approaches (PFM and broader reforms)
- Preconditions for effective implementation of fiscal rules:
  - Reliable data availability and minimum technical forecasting capacity to make budgetary aggregates predictable.
  - Comprehensive budget reporting systems capable of producing in-year and timely end-year reports for internal monitoring.
  - Internal and external audit systems to ensure public resource utilization is fully accounted for.
  - Fiscal data consistent with the budget reporting system and publicly released in line with a pre-announced calendar for external monitoring.
- Broader reforms accompanying fiscal rules:
  - Fiscal responsibility laws often accompany rules and frameworks typically rely on:
    - (i) Legislated broad principles guiding fiscal policy formulation.
    - (ii) Detailed articulation of rolling budget plans and fiscal projections over short, medium, and long horizons.
    - (iii) Effective budget mechanisms and procedures designed to minimize deficit biases (e.g., top-down budgeting, rigorous cost-benefit analysis, program budgeting, strict limits on amending/supplementing budgets).
    - (iv) Strong transparency requirements and public oversight (mandatory publication of regular reports with multiyear fiscal projections and pre-determined disclosures).
- Alternative approaches:
  - Some countries (e.g., Australia and New Zealand) strengthened fiscal frameworks without emphasizing numerical fiscal targets; in such cases fiscal transparency requirements assume greater importance.

### Independent fiscal agencies (Box 2) — roles and examples
- Roles of fiscal councils/independent fiscal agencies:
  - Provide objective analysis of current fiscal developments and costing of budgetary initiatives.
  - Produce independent projections and forecasts of budgetary and macroeconomic variables.
  - Provide normative assessments regarding appropriateness of fiscal policy stance (in some cases).
- The desirable form of a fiscal council is country specific and depends on the fiscal problem and political environment.
- Examples cited:
  - Chile: projection inputs for trend GDP and “trend” copper prices delegated to two independent expert panels.
  - Netherlands: Central Planning Bureau (CPB) provides economic assumptions for the budget and undertakes broad economic research.
  - Hungary: “Fiscal Council” monitors compliance with a new rule from the Fiscal Responsibility Law (November 2008) and provides independent forecasts (not binding).
  - Sweden: Fiscal Policy Council monitors compliance with the surplus target of 1 percent of GDP on average over the business cycle and assesses fiscal sustainability and transparency.
  - U.S.: Congressional Budget Office (CBO) advises Congress, analyzes administration’s budget using its own assumptions, “scores” legislative proposals, and produces in-depth analyses and reports.

### Fiscal responsibility laws — selected country features (Table 2 summary)
- Selected examples of country laws and features (as reported):
  - Argentina: Federal Regime of Fiscal Responsibility (2004) — Original Law dates 1999, 2001; Procedural Rules: Yes; Numerical Targets in FRL: ER; DRCG; Coverage: Yes; Escape Clauses: Yes; Sanctions: Yes.
  - Australia: Charter of Budget Honesty (1998) — Procedural Rules: Yes; Numerical Targets in FRL: -- 5/; Coverage: CG; Escape Clauses: No; Sanctions: No.
  - Brazil: Fiscal Responsibility Law (2000) — Procedural Rules: Yes; Numerical Targets in FRL: -- 5/; Coverage: PS; Escape Clauses: Yes; Sanctions: Yes.
  - Colombia: Organic Law on Fiscal Transparency and Responsibility (2003) — Original Law dates 1997, 2000; Procedural Rules: Yes; Numerical Targets in FRL: BBR; ER; DR; Coverage: NFPS; Escape Clauses: No; Sanctions: Yes.
  - Ecuador: Fiscal Responsibility Law (2005) — Original Law date 2002; Procedural Rules: Yes; Numerical Targets in FRL: BBR; ER; DR; Coverage: PS; Escape Clauses: No; Sanctions: Yes.
  - India: Fiscal Responsibility and Budget Management Act (2003) — Procedural Rules: Yes; Numerical Targets in FRL: BBR; Coverage: CG; Escape Clauses: Yes; Sanctions: No.
  - New Zealand: Public Finance (State Sector Management) Bill (2005) — Original Law date 1994; Procedural Rules: Yes; Numerical Targets in FRL: -- 5/; Coverage: GG; Escape Clauses: No; Sanctions: No.
  - Pakistan: Fiscal Responsibility and Debt Limitation Act (2005) — Procedural Rules: Yes; Numerical Targets in FRL: BBR; DRCG; Coverage: Yes; Escape Clauses: No; Sanctions: No.
  - Panama: Law No. 2 on Economic Activity Promotion and Fiscal Responsibility (2002) — Procedural Rules: No; Numerical Targets in FRL: BBR; DR; Coverage: NFPS; Escape Clauses: No; Sanctions: No.
  - Peru: Fiscal Responsibility and Transparency Law (2003) — Original Law date 1999; Procedural Rules: Yes; Numerical Targets in FRL: BBR; ER; Coverage: NFPS; Escape Clauses: Yes; Sanctions: Yes.
  - Spain: Budget Stability Law (2007) — Original Law date 2001; Procedural Rules: Yes; Numerical Targets in FRL: BBR; Coverage: NFPS; Escape Clauses: Yes; Sanctions: Yes.
  - Sri Lanka: Fiscal Management Responsibility Act (2003) — Procedural Rules: Yes; Numerical Targets in FRL: BBR; DRCG; Coverage: Yes; Escape Clauses: No; Sanctions: No.
  - United Kingdom: Code for Fiscal Stability (1998) — Procedural Rules: Yes; Numerical Targets in FRL: -- 5/; Coverage: PS; Escape Clauses: No; Sanctions: No.
- Legend and notes:
  - ER = Expenditure rule; BBR = Budget balance rule; DR = Debt rule; RR = Revenue rule.
  - Coverage codes: CG = Central government; GG = General government; PS = Public sector; NFPS = Non-financial public sector.
  - Footnotes indicate, for example, that some countries operate de facto rules not spelled out in the FRL; some FRLs apply only to subnational governments.

### Pros and cons of fiscal rules (effects on policymaking)
- Rationale for rules:
  - Aim to correct distorted incentives leading to deficit bias: governments’ shortsightedness and the “common pool problem.”
  - In currency unions, supranational rules can internalize regional costs of fiscal indiscipline and aid monetary-fiscal coordination.
- Concerns and potential drawbacks:
  - Rules adopted without sufficient political commitment or prerequisites may not be sustained and could undermine credibility.
  - Deficit and debt ceilings may induce a procyclical stance in bad times and may be nonbinding in good times.
  - Rules are often silent on the composition of fiscal adjustment, risking cuts to high social-return capital spending and potential negative long-term growth impacts.
  - Rules may divert political capital away from other priorities (e.g., long-term structural reforms).
  - Rules can encourage “creative” accounting and off-budget operations, reducing transparency—particularly tempted in environments of large deficits and debts.

*Source: IMF staff analysis as presented in the chapter on fiscal rules (dataset and findings summarized from the provided PDF content).*

### 21.      Empirical studies suggest that national fiscal rules have been generally

### 21.      Empirical studies suggest that national fiscal rules have been generally

### Empirical findings on fiscal rules and performance
- For EU countries, tighter and more encompassing fiscal rules are correlated with stronger cyclically adjusted primary balances. The relation weakens, however, when measuring fiscal performance in terms of changes in public debt-to-GDP ratios. This may be an indication that creative accounting could have played a role in conforming to the rules’ requirements.
- By type of rule:
  - Budget balance and debt rules have contributed to better budgetary outcomes.
  - For expenditure rules, an impact is found only in terms of restraining primary spending.
- Government level matters: rules for higher levels of government have been associated with more fiscal discipline than those applying to local governments.
- Design features associated with better performance include a strong legal basis of rules and strict enforcement.
- Fiscal rules do not automatically enhance credibility in market risk premia. Staff analysis for OECD countries suggests a direct “credibility reward” is reaped primarily by countries that had already pursued reasonably prudent policies (Appendix IIb); for these countries there was a beneficial impact in terms of lower risk premia.
- In OECD countries, the size of fiscal consolidations was significantly larger when national or supranational fiscal rules were present (Guichard et al., 2007).
- For EU countries, stronger and wider fiscal rules—as measured by a fiscal rules index—were associated with a greater likelihood for successful fiscal consolidation (European Commission, 2007).
- Econometric evidence on whether national fiscal rules have contributed to triggering fiscal consolidations in EU countries is not clear-cut. The fiscal rules index is only weakly significant in explaining the probability of a fiscal retrenchment occurring (Larch and Turrini, 2008), though the probability that rules trigger a sharp consolidation rather than a gradual one is somewhat higher.

### New evidence on fiscal rules and large adjustments
- Review basis: 24 episodes in G-20, OECD, and European Union member states since 1980 (see Box 3). Episodes abstracted from oil exporters and those driven mainly by rapid real GDP growth and inflation reduce the sample to 24.
- Average outcomes in these large-adjustment episodes:
  - Countries in the sample managed to reduce their public debt ratios on average by 27 percent of GDP (or 40 percent of the initial debt ratio) over a period of about seven years.
- Comparative features (Figure 6 and Table 3): countries with fiscal rules versus those without rules were associated with:
  - Larger reduction in public debt ratio and over a longer uninterrupted period.
  - More front-loaded tightening of the fiscal stance (measured by changes in the cyclically adjusted primary balance).
- Timing of rules in large adjustments:
  - In nearly half of the 24 successful cases since 1980, countries started the fiscal consolidation with national fiscal rules in place—often introduced specifically to reverse fiscal deterioration (examples: Finland and Sweden after early 1990s crisis).
  - Seven countries introduced fiscal rules after their debt ratios had started to decline.
- Table 3 (Characteristics of Large Adjustments in Countries With and Without Fiscal Rules) — values shown by column order as in source:
  - Initial public debt: 48.5 69.7 70.3 68.8
  - Reduction in public debt: 20.3 29.7 24.0 38.5
  - Relative reduction in debt (percent of initial public debt ratio): 42.6 42.9 33.1 58.2
  - Adjustment length (years): 6.3 8.2 7.1 10.0
  - Annual reduction in public debt: 4.0 3.7 3.3 4.3
  - Front-loading of reduction in public debt ratio (percent) 1/: 49.5 39.1 40.0 44.0
  - Front-loading of adjustment in CAPB (percent) 3/: 1.3 9.6 40.0 0.1
  - Memorandum item: Number of countries: 6 18 11 7
  - (Notes: 1/ Reduction in public debt-to-GDP ratio that occurred in first three years relative to total change in the public debt-to-GDP-ratio. 2/ Cumulative change in the cyclically adjusted primary balance (CAPB) in first three years relative to reduction in the public debt-to-GDP-ratio over the whole adjustment period. Table values are percent of GDP unless indicated otherwise.)
- Role and types of rules in large adjusters:
  - Combining budget balance with expenditure rules appears particularly effective; expenditure rules were more widespread among large adjusters and frequently combined with budget balance rules.
  - Rules in large adjusters tended to have wide coverage (general government or supplemented by strict regional/local targets) and stronger monitoring/enforcement mechanisms; statutory basis varied (some enshrined in law; others set by political agreements).

### Caveats and methodological concerns
- Correlation does not imply causation: fiscal rules and improved fiscal performance could both be driven by omitted determinants (e.g., political or budgetary institutions or processes), creating potential statistical bias.
- Reverse causality is possible: improved fiscal performance may lead to adoption of rules to “lock in” gains or signal commitment.
- Instrumental variable methodology suggests bias from reverse causality may be small (Debrun et al., 2008), but omitted variable problems can still lead to model misspecification not addressed by that method.
- Full resolution requires broader data on commitment and budgetary processes, which are often unavailable. Nonetheless, the widespread adoption of rules by almost half of the Fund membership suggests rules may confer some benefit.

### Designing and implementing effective fiscal rules (principles)
- Three components of effective fiscal policy rules:
  - An unambiguous and stable link between the numerical target and the ultimate objective, such as public debt sustainability.
  - Sufficient flexibility to respond to shocks so the rule does not exacerbate adverse macroeconomic impacts; flexibility may be needed for output, inflation, interest rate and exchange rate volatility, and other shocks (distinguishing between temporary and persistent shocks is essential).
  - A clear institutional mechanism to translate deviations from targets into incentives for corrective actions: e.g., a mandated correction mechanism over a well-defined time frame and an explicit enforcement procedure.
- Appropriate variable to constrain depends on:
  - Link to debt ratio, controllability and operational guidance, transparency and ease of monitoring.
- Pros and cons of candidate anchors:
  - Overall budget balance (ratio to GDP): generally meets operational criteria; closely linked to debt ratio though off-budget operations or financing items can weaken the link; excluding debt service payments raises controllability but weakens anchor to debt.
  - Debt ratio: directly linked to ultimate objective but operationally challenging due to lags, volatility from interest rates/exchange rates and “below-the-line” financing operations.
  - Expenditure level: controllable and easy to monitor but not directly linked to debt without considering revenues; most useful combined with a budget balance rule or freezing tax parameters (Anderson and Minarik, 2006), though loopholes from tax expenditures may arise.
- Response to output shocks:
  - Targeting cyclically adjusted or structural balances permits flexibility by allowing automatic stabilizers to operate; if cycle is well defined, a structural balance consistent with the debt objective can be attained.
  - Growth-based balance: variant using deviations of output growth from trend rather than the output gap; useful where output gap estimation is difficult but risks procyclicality (e.g., early recovery where actual growth exceeds trend while output gap remains negative).
  - Over-the-cycle balance: requires average nominal balance target over a full economic cycle, offering flexibility but potentially reducing credibility and requiring precise cycle dating.
  - For commodity exporters: adjust for volatile commodity prices via structural balance adjustments for commodity revenue fluctuations (as in Chile), or target a non-commodity balance; may use a notional fund to save windfalls above target for future shortfalls.

*Source: IMF staff analysis in the supplied content unit.*

### 37.      To implement a structural balance rule, three elements are needed.

### 37.      To implement a structural balance rule, three elements are needed.

### Three required elements
- First, a structural balance target.
  - Definition: the balance that would lead to a sustainable debt level.
  - Should account for the expected increase in spending due to demographic and other factors, as well as projected growth.
  - Example: the structural surplus objectives in Denmark and Finland account explicitly for the impact of rising age-related spending.
- Second, an estimation of the output gap.
  - Can be done using a simple statistical procedure (e.g., the Hodrick-Prescott (HP) filter), which produces symmetric estimates of output gaps.
  - Dependence: on the sensitivity parameter and influence of the latest data (Appendix IVa).
  - Note: estimates can be subject to revisions ex post; alternative is the production function approach (more data demanding).
- Third, estimates of revenue and expenditure elasticities.
  - Can be based on analysis of the past relationship between the budget and the output gap, accounting for factors that may change elasticities (e.g., tax policy changes or expenditure reforms) (Appendix IVa).
  - Important issue: impact of cycles in corporate profits and asset prices on revenues may not be adequately captured by changes in output; magnitude can be significant but adjusting for these effects is challenging and seldom systematically undertaken.

### Box 4 — Structural Balance Fiscal Rules: appropriate responses and variants
- A. Appropriate Response to Output Shocks
  - Basic structural balance rule (formal):
    - b_t = b* + a y_t^G , a>0
      - b_t: overall balance in the current year
      - b*: medium-term balance target
      - a: semi-elasticity of budget balance with respect to the output gap
      - y_t^G: output gap in the current year
  - Growth-based balance variant:
    - b_t = b* + a (g_t - g*) , a>0
      - g_t: GDP growth rate in the current year
      - g*: average long-run GDP growth rate
    - Note: overall balance reacts to changes in growth rate rather than level of output; could give rise to a procyclical response.
- B. Responding to Past Deviations
  - Augmented structural balance rule:
    - b_t = b* + a y_t^G - c (b_{t-1} - b*) , a>0 , 0<c<1
      - c: pace of correction to previous-year deviation
    - Effect: reduces magnitude of balance deviation while allowing countercyclical measures.
  - Augmented growth-based balance rule:
    - b_t = b* + a (g_t - g*) + e (b_{t-1} - b*) , a>0 , 0<e<1
      - e: pace of adjustment when previous-year balance is away from b*
    - Effect: delays adjustment back to target and reduces procyclicality (opposite sign effect to augmented structural balance).

### Role of independent fiscal agencies / fiscal councils
- An independent body can:
  - Reduce risk of biased estimates of needed parameters and assessments of required adjustment.
  - Be particularly useful amid heightened uncertainties about the economic cycle and potential growth when future trends may differ appreciably from the past.
- Policy choices remain with policymakers; the agency’s role is analytical and credibility-enhancing (Box 2).

### C. Response to Inflation
- Inflation impacts fiscal rules differently depending on target construction:
  - Nominal balance, expenditure, and revenue ceilings are most affected.
  - Even ratios to GDP can be affected due to differential impacts on numerator and denominator.
  - Debt-to-GDP ratio may be affected by inflation: interest bill increase in response to inflation-induced erosion in nominal debt may differ from increase in nominal GDP.
  - Examples:
    - Nominal expenditure ceilings (e.g., multiyear spending limits in Sweden): higher inflation implies lower real volume of goods and services provided.
    - Real-term budget aggregate ceilings (e.g., real caps in Finland and the Netherlands): protected from inflation effects.
- Considerations:
  - Fiscal rules that target real aggregates fully accommodate price increases, which may be undesirable when real savings are needed to avoid transmitting inflationary shocks.
  - Nominal ceilings do not allow compensation for higher price levels—may be appropriate in countries with large governments where spending inertia linked to inflation is large.
  - Inflation-adjusted fiscal target (eliminating the inflationary component of debt service from the balance) may be more appropriate when inflation effects distort fiscal response.

### D. Dealing with Other Shocks
- Additional shocks to consider: interest rate and exchange rate movements affecting debt service (especially when debt stock is large, short-term, and/or foreign currency denominated).
- Potential policy choice:
  - Targeting the primary balance may be helpful when shocks are transitory but frequent.
- Rare events:
  - Use an “exceptional circumstances clause” allowing temporary deviation from the rule for rare shocks or large structural reforms.
  - Essential features for such a clause:
    - Very limited range of triggering factors.
    - Clear guidelines on interpretation of events.
    - Specification of the path back to the rule.

### E. Response to Past Deviations
- Deviations need not always trigger adjustment:
  - If deviation reflects nonsystematic or temporary factors, no adjustment required (expectation of offsetting over medium term).
  - When deviations are not temporary or are not “one offs,” mechanisms to respond to past deviations are essential for credibility.
- Modifying the structural balance rule:
  - After large downward shocks leading to persistent debt accumulation, modify structural balance to account for past deficits (augmented structural balance).
  - Calibrate required adjustment to target a specific rate of decline in the debt ratio while preserving countercyclicality.
  - Augmented growth-based rule can reduce procyclicality by gradual adjustment when deficit is above ceiling and automatic smooth adjustment to past deviations.

### F. Comparative properties and examples
- Trade-offs:
  - Weight on adjustment to past deviations relative to cyclicality parameter determines convergence speed and degree of countercyclicality.
  - Low weight on past deviations → slow adjustment, stronger countercyclicality.
  - High weight on past deviations → rapid convergence, may force deficit shrink while output gap still widening (see Appendix III); complexity may weaken credibility in less advanced economies.
- Simulation findings (Appendix III):
  - In persistently low-growth environment, augmented growth-based balance rule performs well: ensures convergence of deficit back to target and places debt on sustainable path faster than other structural variants.
  - Under large abrupt shocks:
    - Augmented growth-based balance rule reduces debt ratio faster under adverse shocks but at cost of reduced countercyclicality.
    - Augmented structural balance rule performs better after large positive shocks by saving a larger share of revenue windfalls during booms.
  - Simulation scenarios included: low growth, large shock, boom-bust, and contingent liability (debt ratio rises by 15 percentage points).
- Country examples with “debt brake” mechanisms:
  - Swiss rule:
    - Ex post deviations stored in a notional account.
    - Government must act when negative balance in account exceeds 6 percent of expenditure (about 0.6 percent of GDP) and bring it back below this threshold within the next three years.
    - Forecast errors in real GDP growth and output gap feed fully into the notional account.
  - German rule:
    - Notional account adjustment triggered when a deficit limit of 1 percent of GDP in the notional account is breached; adjustment required only in times of economic recovery.
    - Maximum annual adjustment in structural terms capped at 0.35 percent per year.
    - Ex post structural balance corrected for forecast error in real GDP growth (forecast errors not fed fully into the notional account as in Swiss case).

### F. What is the Appropriate Coverage?
- Two coverage issues:
  - Level of government: should rule apply to central government, subnational governments, social security accounts, public companies?
  - Items included in target variable: which expenditures and revenues to cover?
- General points:
  - Broad aggregates usually require rules at different government levels; general government coverage more common with supranational rules.
  - National rules often target central government aggregates with separate rules for subnationals; public sector aggregates (including nonfinancial public enterprises) may be considered where quasi-fiscal activities are large.
- Pros and cons of selective coverage (Table 4 highlights examples):
  - Interest payments:
    - Arguments to exclude: not under government control short run; may be volatile and require short-term adjustments (capital spending often easiest cut).
    - Arguments to include: compatible with objectives for overall public debt and tax burden.
  - Cyclically-sensitive expenditure:
    - Arguments to exclude: not under short-run control; may weaken countercyclicality if included.
    - Arguments to include: avoids politicized exclusions; most cyclicality is on revenue side.
  - Capital expenditure:
    - Arguments to exclude: politically easier to cut than current spending; excluding may lead to reclassification of current spending as capital.
    - Arguments to include: compatible with debt objectives; more transparent; not all capital spending raises productivity; other human capital spending could be as effective as public investment.
  - Note: “golden rules” that exclude capital expenditure risk negative impacts on long-run growth if capital spending is cut.

*Source: IMF content unit "37. To implement a structural balance rule, three elements are needed."*

### Box 6. Coverage for Primary Commodity Exporters

### Box 6. Coverage for Primary Commodity Exporters

### Purpose and advantages of targeting a noncommodity fiscal balance
- Targeting the fiscal balance that excludes revenues from primary commodity exports (the noncommodity balance) can:
  - Insulate the budget from the volatility of commodity revenues.
  - Allow authorities to focus on a fiscal aggregate that can be controlled more readily than the overall balance.
  - Permit expenditures to remain stable: during high commodity prices the overall budget might accumulate a surplus, and during low prices a deficit, but expenditures would be unaffected.1/
- Advantages over an unadjusted overall budget target:
  - Prevents budgeted spending levels from rising and falling directly with commodity revenue forecasts irrespective of cyclical or efficiency considerations.
  - Reduces the risk of spurring inflationary pressures tied to volatile commodity receipts.
  - May provide room for intergenerational equity by targeting the level of net wealth that includes consumption out of resource assets (example noted: Norway’s structural non-oil deficit targeted by fiscal guidelines excludes oil-related revenues and expenditures and makes various adjustments including for cyclical fluctuations in mainland economic activity).

### Risks of a noncommodity-balance target and proposed safeguards
- Main concern:
  - Targeting a given noncommodity balance could lead to excessive headline deficits if commodity prices or output fall sharply: “With a given noncommodity balance, a steep decline in commodity revenues—say, from a collapse of prices—could lead to a large increase in the overall deficit.”
- Suggested safeguards:
  - Complement the noncommodity deficit target with a limit on the cumulative deviation of the overall deficit from its notional target over a rolling period. The notional target is defined as the projected headline budget deficit given the official noncommodity target and a projection of commodity revenues.
  - If the cumulative deviation in headline outturns exceeds the limit, require authorities to announce measures to reduce the cumulative deviation to zero over a prescribed period (comparable to the correction mechanism of the Swiss “debt brake”).
  - Alternative: adopt a structural-balance approach that corrects for commodity price deviations from long-term levels (example noted: Chile’s budget balance rule, which corrects for deviations in the prices of copper and molybdenum from their long-term levels).

### Implementation caveats and related design issues
- Footnote on sustainability assessment:
  - 1/ “A sustained period of high or low commodity prices could have an impact on the assessment of the sustainable noncommodity balance, which would affect the level of spending.”
- Interaction with other exclusions (example: capital expenditure “golden rule”):
  - Excluding volatile items from targeted fiscal aggregates can make targets more transparent and easier to monitor and enforce, but including volatile items reduces stability and predictability and may require ad hoc adjustments in other budgetary items.
  - The frequent exclusion of capital expenditure (the “golden rule”) is justified on grounds that such spending contributes to long-run growth, but raises concerns:
    - Weakens the link with gross debt.
    - Not all capital expenditure is necessarily productive.
    - Other expenditures (health, education) may raise productivity more.
    - Exclusion risks “creative” accounting, lower transparency, and a weaker link to sustainability.
- Net versus gross debt as the ultimate target:
  - Net debt (gross debt minus financial assets) is desirable in principle as it accounts for the government’s full financial balance sheet.
  - Gross debt indicators are generally used in fiscal rule frameworks, possibly because they better reflect potential financing risks from tapping limited domestic capital markets in many countries.

### Examples and references in practice (as noted in the text)
- Norway: structural non-oil deficit targeted by fiscal guidelines excludes the budget’s oil-related revenues and expenditures, with adjustments for cyclical fluctuations in mainland economic activity.
- Switzerland: cited for the “debt brake” correction mechanism analogy.
- Chile: budget balance rule defined in structural terms, correcting for deviations in copper and molybdenum prices from long-term levels (Appendix I).

*Source: Box 6, “Coverage for Primary Commodity Exporters,” _121609 - Box 6. Coverage for Primary Commodity Exporters*

### 63.      In countries with no existing rule and relatively small adjustment needs, early

### In countries with no existing rule and relatively small adjustment needs, early

### Early implementation where adjustment needs are small
- Introducing a well-designed and implemented rule, supported by political commitment and appropriate institutional mechanisms, can:
  - Help guide fiscal policy and anchor expectations regarding public finance sustainability.
  - Forestall adverse market reaction including through higher risk premia.
  - Facilitate the conduct of prudent fiscal policy.
- Early implementation may not be needed for all countries with limited adjustment needs, but can be useful where there are growing concerns about governments’ ability to restrain future spending pressures (for instance, related to aging) or potential exposure to further global shocks.

### Countries with large consolidation needs and high uncertainty
- Early implementation of a rule or a rapid return to fiscal targets envisaged by existing rules may be infeasible when:
  - Countries face large fiscal consolidation needs and unusual uncertainty.
  - The environment is characterized by high risk, lower potential growth, and rising global sovereign bond supply.
- Implementing a fiscal rule targeting appropriate medium-term fiscal targets could entail an excessive pace of fiscal adjustment. Example:
  - For the average of the advanced G-20 countries, an early implementation of a fiscal rule targeting, say, a zero structural balance in 2011 would entail an adjustment of around 4½ percentage points of GDP, in an environment of significant economic uncertainties and a fragile recovery.22

### Recommended sequencing: transition plans before operationalizing rules
- A time-bound, realistic consolidation plan should precede the implementation of the rule in such countries. Benefits:
  - Enhances policy credibility.
  - Facilitates convergence to the eventual fiscal rule target.
- During the transition:
  - Clearly specified multiyear structural balance paths backed by appropriate benchmarks and policies can be instrumental in achieving required debt reduction while ensuring a feasible adjustment pace.
  - When economic conditions have normalized, the fiscal rule can be implemented or operationalized again.23

### Design and announcement strategy during transition
- It may be advisable to design and announce a credible rule-based framework and a timeframe for its implementation while:
  - Allowing time to reach social consensus on the framework.
  - Ensuring supporting budgetary procedures and institutional mechanisms are in place.
  - Coordinating the fiscal framework across different levels of government (and/or the supranational level where relevant) to ensure consistency in fiscal targets.
  - Developing monitoring and enforcement mechanisms.
- A useful strategy is to accompany the fiscal consolidation plan with the design and announcement of a fiscal rule to be implemented when economic conditions return to normal.

### Issues for discussion (enumerated points raised in the source)
- There has been a marked increase in the adoption of rule-based frameworks in many advanced and developing countries. How do Directors view this increase? Have these frameworks helped enhance fiscal policy credibility and anchor medium-term expectations regarding fiscal sustainability?
- Would Directors consider that fiscal rules can play a useful role in the conduct of fiscal policy even if they are not necessarily appropriate for all countries? While commitment is essential for rules to be effective, can they in turn enhance it? How do Directors view the adoption of institutional fiscal frameworks, including FRLs, which do not rely on quantitative numerical rules?
- What design features would Directors regard as most desirable and appropriate? How do they view the trade-off between credibility and flexibility in the adoption of rules? What are the measures that can be adopted to enhance credibility while preserving adequate flexibility? Would they agree that to provide flexibility in response to output shocks, cyclically adjusted balance rules are potentially useful options?
- How do Directors view the role of supporting budgetary and monitoring institutions, including public financial management, and fiscal councils, in ensuring the effectiveness of rules?
- Do Directors agree that given the large adjustment needs, and high uncertainty, it would be desirable for some countries to adopt a time-bound and realistic consolidation plan before implementing a fiscal rule? Nonetheless, would they consider it advisable to design and announce early-on a credible rule-based framework, and a timetable for its introduction?

*Source: _121609 - 63.*

### introduction or revision of the rule; the monitoring and implementation procedures in place;

### _121609 - introduction or revision of the rule; the monitoring and implementation procedures in place;

### Methods used
- Three econometric methods:
  - Duration analysis methods (parametric and nonparametric hazard models).
  - Conditional fixed effects logit model.
  - Tobit model for the number of fiscal rules for countries with numerical targets.
- Sample and periods:
  - Sample of 68 economies includes all OECD countries and the emerging market economies in the EMBIG Index.
  - Regression sample of 68 advanced and emerging economies in the period 1985–2008.
  - Separate analysis sample includes 22 OECD countries for 1990–2008.

### Determinants of fiscal-rule adoption (univariate/bivariate hazard results)
- Countries with better initial fiscal and economic conditions are more likely to introduce fiscal rules.
- Reported hazard ratios for countries with above-average macroeconomic indicators:
  - Countries with a larger primary surplus had a 40 percent higher probability of adopting a rule.
  - Countries with a ratio of public debt to GDP that was below the sample average had three times the chance to adopt a rule compared to other countries.
  - High inflation and currency depreciations were associated with lower probabilities of introducing a fiscal rule.
  - Positive GDP growth and higher reserves to GDP increased the likelihood of adopting a rule.
- The effect of terms of trade shocks is not found to significantly influence the probability of introducing a fiscal rule.
- Note: About 40 percent of GDP on average during the sample period is the sample average public debt benchmark referenced.

### Multivariate regression results and policy-design correlates
- Multivariate (conditional fixed effects logit and fixed effects Tobit) results confirm economic determinants:
  - Good fiscal performance positively affects both the likelihood of having fiscal rules and the average number of quantitative fiscal targets.
  - Correlation between having fiscal rules and the primary fiscal balance is positive; countries in healthier fiscal conditions have more fiscal rules.
  - Poor initial fiscal conditions delay introduction of fiscal rules; countries need prudent and credible measures first.
  - Relationship with public debt is nonlinear: higher levels of public debt discourage fiscal rules up to a threshold; for high-debt countries rules may be instrumental in restoring fiscal stability.
    - Threshold estimated to be in the range of 80 percent to 100 percent of GDP.
- Macroeconomic conditions correlated with rule presence:
  - High inflation, low and volatile economic growth, and sharp exchange rate movements are negatively correlated with the probability of having rules.
- Initial conditions affect rule design:
  - Expenditure rules tend to be implemented in countries with better macroeconomic conditions.
  - Larger fiscal deficits (unlike debt levels) do not influence the use of debt rules.
  - Exchange rate stability, low public debt, and limited inflation are significant determinants of budget balance rules.
  - Low levels of public debt and price stability increase the likelihood of having revenue rules.
  - Presence of supranational fiscal rules increases the number of fiscal targets.
  - Federal states tend to have a wider coverage of fiscal rules.

### Credibility effects of fiscal rules: evidence from market risk premia
- Conceptual point: a fiscal rule that credibly commits a government to a sustainable fiscal path should reduce market risk premia, independent of accompanying fiscal improvements.
- Empirical staff findings:
  - Rules per se may not be credibility-enhancing; credibility rewards accrue primarily to countries with a prior record of reasonably prudent policy.
  - During 1990–2008, OECD countries with public debt ratios below 70 percent of GDP experienced a reduction in 10-year bond spreads by 10–20 basis points in the long run, depending on statutory rank and quality of monitoring and enforcement.
  - In a full sample of OECD economies, the presence of a fiscal rule did not affect spreads once macroeconomic and fiscal conditions were controlled for.
- Cyclical contingency:
  - Explicit cyclical contingencies enhance credibility by allowing flexibility in downturns while being robust if well-monitored and enforced.
  - Currently eight OECD countries operate fiscal-rule frameworks that explicitly allow for countercyclical fiscal policy in some form.
  - Median market reactions: reforms that substantially strengthened the fiscal-rule framework while introducing cyclical contingency were best received by markets in the quarter of implementation.
  - Estimates suggest a moderate strengthening of fiscal rules accompanied by introduction of a cyclicality contingency can lower spreads by 10 basis points upon impact, and up to 20 basis points in the long run.
  - However, cyclically contingent fiscal rules have so far been implemented mainly in countries with high market confidence: seven out of the eight countries with cyclical contingencies during 1990–2008 consistently enjoyed below-average spreads and typically had low spreads prior to reform.

### Simulation assessment of alternative fiscal rules (Appendix III)
- Purpose: explore properties of different fiscal rules via simulations in response to exogenous shocks and in general equilibrium.
- Conclusion from simulations:
  - Cyclically adjusted balance rules combined with mechanisms to correct past deviations from a specific target are best suited to achieve a significant reduction in public debt while preserving room for countercyclical fiscal policy.
- Three variants of cyclically adjusted balance rules simulated:
  - (i) Basic structural balance rule: allows temporary deviations in the overall nominal deficit according to cyclical developments.
  - (ii) Augmented growth-based rule: permits a higher deficit when current-year GDP growth is below trend and calls for gradual adjustment when initial deficit is above target.
  - (iii) Augmented structural balance rule: incorporates (i) plus an automatic correction mechanism for past deviations from the target.
- Simulation findings:
  - Under a large shock scenario:
    - All rules ensure progressive narrowing of the budget deficit after the initial shock, but at different speeds.
    - Basic structural balance rule allows automatic stabilizers to operate but is less successful at reducing public debt after the shock.
    - Augmented structural balance and augmented growth-based rules provide room for countercyclical responses while incorporating correction mechanisms consistent with debt sustainability.
    - The augmented structural balance rule implies a stronger correction (more limited countercyclical response) than the augmented growth-based rule; the augmented growth-based rule implies a tighter fiscal position when the output gap is still large as growth returns above trend.
  - In a low-growth scenario:
    - The augmented growth-based balance rule ensures debt consolidation.
    - The basic structural balance rule could place the debt-to-GDP ratio on an unsustainable path because it allows automatic stabilizers to expand throughout prolonged low growth.

_Italic: _121609 - introduction or revision of the rule; the monitoring and implementation procedures in place;_

### Appendix III. Figure 1. Respon se of Overall Balance an d D ebt-Ratio to Macroecono mic Shocks 1/

### Appendix III. Figure 1. Response of Overall Balance and Debt-Ratio to Macroeconomic Shocks 1/

### Responses of the Overall Balance (Simulation snapshots by shock)
- Large shock (panels show time series labeled T-1, T+1, T+3, T+5, T+7, T+9, T+11, T+13, T+15):
  - Vertical axis markers: -12.0, -10.0, -8.0, -6.0, -4.0, -2.0, 0.0, 2.0
  - Series displayed: Aug. growth-based balance; Output gap; Basic structural balance; Aug. structural balance
  - Text finding: “The augmented growth-based rule leads to the fastest reduction in debt in this scenario as the overall balance is tightened both as a result of a return to trend output growth and the operation of the deficit-convergence mechanism.”
- Low growth:
  - Vertical axis markers: -10.0, -8.0, -6.0, -4.0, -2.0, 0.0, 2.0
  - Series displayed: Aug. growth-based balance; Output gap; Basic structural balance; Aug. structural balance
- Contingent liability shock:
  - Vertical axis markers: -4.0, -3.0, -2.0, -1.0, 0.0, 1.0
  - Series displayed: Aug. growth-based balance; Basic structural balance; Aug. structural balance
  - Text finding: “All rules behave similarly in the case of a sudden increase in debt—and, hence, interest payments—reflecting the emergence of contingent fiscal risks.”
- Boom-bust:
  - Vertical axis markers: -4.0, -2.0, 0.0, 2.0, 4.0, 6.0, 8.0, 10.0, 12.0
  - Series displayed: Aug. growth-based balance; Output gap; Basic structural balance; Aug. structural balance
  - Text finding: “In a very volatile economic environment, the augmented structural balance rules work better. Under a scenario of output boom and bust, these rules reduce the fluctuations in the fiscal balance compared to the basic structural balance rule, since they include mechanisms for reducing the surplus as output—or GDP growth—increasingly deviates from potential. In the long run, however, all rules induce a surplus in the primary balance and consequently, the debt ratio would follow a downward path following the bust period.”

### Responses of Gross Debt (Simulation snapshots by shock)
- Gross debt — Large shock:
  - Vertical axis markers: 0.0, 12.5, 25.0, 37.5, 50.0, 62.5, 75.0
  - Series displayed: Aug. growth-based balance; Basic structural balance; Aug. structural balance
- Gross debt — Low growth:
  - Vertical axis markers: 0.0, 12.5, 25.0, 37.5, 50.0, 62.5, 75.0
  - Series displayed: Aug. growth-based balance; Basic structural balance; Aug. structural balance
- Gross debt — Contingent liability:
  - Vertical axis markers: 0.0, 12.5, 25.0, 37.5, 50.0, 62.5, 75.0
  - Series displayed: Aug. growth-based balance; Basic structural balance; Aug. structural balance
- Gross debt — Boom-bust:
  - Vertical axis markers: 0.0, 20.0, 40.0, 60.0, 80.0
  - Series displayed: Aug. growth-based balance; Basic structural balance; Aug. structural balance
- Text finding: “The augmented growth-based rule leads to the fastest reduction in debt in [the large shock] scenario... All rules behave similarly in the case of a sudden increase in debt—and, hence, interest payments—reflecting the emergence of contingent fiscal risks.”

### Simulation scenarios and assumed real GDP growth (Table 1)
- Table heading: Assumed Real GDP Growth Rates in Simulation Scenarios (Percent change)
- Columns: T-1, T, T+1, T+2, T+3, T+4, T+5, T+6, T+7, T+8, T+9
- Baseline:
  - Values: 1.5, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0
- Large shock:
  - Values: 1.5, 4.0, -3.0, 0.5, 2.0, 7.0, 7.0, 6.0, 5.0, 4.5, 4.5
- Low growth:
  - Values: 1.5, 4.0, 3.0, 3.0, 3.0, 3.0, 3.0, 3.1, 3.2, 3.3, 3.4
- Fiscal risk:
  - Values: 1.5, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0
- Boom-bust:
  - Values: 1.5, 4.0, 7.0, 7.0, 7.0, 7.0, -5.0, 0.0, 3.0, 4.0, 4.5
- Memorandum item: Commodity price index
  - Values: 100, 104, 107, 110, 103, 99, 96, 95, 96, 97, 97

### Commodity-price adjustment and SBCRA (Appendix III Figure 2 summary)
- Mechanism: Structural balance rule enhanced to allow temporary deviation of the overall balance target when commodity export revenue deviates from a predetermined level.
- Simulation setup: Uses the same output assumptions as the boom-bust scenario plus “a large spike in the export commodity price followed by a sharp fall.”
- Panel notes:
  - Overall balance — Boom-bust vertical axis markers: -5.0, -2.5, 0.0, 2.5, 5.0, 7.5, 10.0, 12.5
  - Commodity price index (RHS) plotted with markers: 90, 95, 100, 105, 110, 115, 120, 125
  - Gross debt — Boom-bust vertical axis markers: 0, 5, 10, 15, 20, 25, 30
  - Series: SBCRA; Basic structural balance; Output gap; Commodity price index (RHS)
- Text finding: “The modified rule ensures that a surplus is recorded whenever commodity revenue deviates upwards from its target, despite a zero output gap (and vice versa).”
- Policy implication: “For the commodity-augmented structural balance rule, the enhanced stabilization properties come at the price of a more volatile government net worth aggregates. However, countries applying this type of rule can accumulate commodity-revenue fund in times of windfall that can be run down in times of shortfall—as it is done, for example, in Chile.”

### Macroeconomic feedbacks, GIMF simulations, and stabilizing properties
- Simulations with feedbacks via the IMF’s Global Integrated Monetary and Fiscal model (GIMF) confirm:
  - “Macroeconomic stabilizing effects of cyclically adjusted balance rules under both demand and supply shocks to the economy.”
  - For an emerging economy with significant commodity export revenue, “the simulations also point to the desirability of adjusting the structural budget target for deviations of commodity-related revenue from its trend.”
- Trade-offs highlighted:
  - “The volatility of macroeconomic variables that are likely to be of concern to policymakers (output, employment, consumption) is higher under a balanced budget rule than under a structural balance rule.”
  - Structural balance rules permit countercyclical transfers to credit-constrained agents during negative demand shocks, stabilizing income and consumption.
  - Cost: “The more active countercyclical policy comes at the price of significant debt accumulation over the peak of the downturn.”
- Debt-management policy tool:
  - “A structural balance rule with medium-term debt objective can help needed debt reduction in the short run. An economy that starts at the debt target, or close to it, and suffers an adverse shock can initially have countercyclical fiscal policy. As debt grows above its target, however, the modified structural balance rule will call for an increasing annual adjustment to moderate the debt spike.”

### Practical aspects of calculating structural balances (Appendix IVa) — output gap and elasticities
- Output gap estimation methods:
  - Hodrick-Prescott (HP) filter:
    - Advantage: requires only output series; objective and reproducible; symmetric over the cycle.
    - Drawbacks and mitigations:
      - End-point bias: “To minimize this bias, forecasts that move the series end-point forward could be used, provided these are reasonable forecasts.”
      - Poor response to changes in duration of the cycle; protracted recessions may affect potential output that the filter does not capture.
      - Structural breaks: “The break in the output series needs to be identified beforehand, and the series adjusted for the break can then be used to estimate potential output with the filter.”
  - Production function approach:
    - Advantage: based on economic fundamentals; commonly uses a Cobb-Douglas functional form.
    - Disadvantages: increased methodological complexity and data demands; requires projections of factor inputs for future potential output.
    - Note: “Production function estimates are generally obtained from a simple linear regression estimation... ensuring that surpluses and deficits cancel out over the cycle.”
- Output elasticities of revenue and expenditure:
  - Revenue elasticities tend to be higher than expenditure elasticities (except unemployment benefits).
  - Elasticities fluctuate over time: pre-crisis elasticities likely exceed post-crisis elasticities due to sectoral composition changes.
  - Practical recommendation: disaggregated analysis of individual tax bases and expenditure elements to improve elasticity estimates.
  - Example practice: “For the EU fiscal framework tax and expenditure elasticities are being estimated based on a commonly agreed method developed by the OECD.”

### Fiscal sustainability technical notes (Appendix IVb)
- Notation and definitions:
  - tp denotes the primary balance in period t as a ratio to GDP.
  - td denotes the debt at the end of year t as a ratio to that year’s GDP.
  - Growth-adjusted interest rate λ defined by λ = (1 + i)/(1 + γ) − 1 (stated as 1/(1+γ) times (1+i) with equivalent expression rg/(g) context), and equivalently 1 + r = (1 + λ)(1 + g) interpretation in text.
- Key assumptions:
  - Discussion generally assumes λ strictly positive (0 < λ), i.e., real interest rate r exceeds real growth rate g (the modified golden rule).
- Intertemporal budget constraint and no-Ponzi game condition:
  - Government intertemporal budget constraint (equation (0.1)):
    - 0
      1
      (1)
      ∑ t t t d p λ − ∞ = =+ 
  - No-Ponzi game condition (equation (0.2)):
    - lim (1)0 N N N d λ − + = ∞ → 
  - Recursive year-by-year constraint (equation (0.3)):
    - 1
      (1)
      t t t t d d p λ − = + −
  - Iterated identity for future debt (equation (0.4)):
    - 0
      1
      (1)(1)
      N Nt Nt t d d p λ λ − − = = + + + ∑
  - Logical equivalence: taking lim N→∞ on (0.4) shows the no-Ponzi game condition (0.2) implies the intertemporal budget constraint (0.1), and vice versa.
- Boundedness of the debt ratio:
  - If the primary balance-to-GDP ratio is bounded above, then the no-Ponzi game condition implies the debt ratio is bounded above.
  - Argument: with strictly positive λ, if debt ratio were unbounded it would eventually exceed the stabilizing capacity of the highest feasible primary balance, causing explosive debt growth and violating the no-Ponzi game condition.
  - If λ is not positive, the no-Ponzi game condition directly implies the debt ratio must be bounded.

*Source: Staff calculations.*

### Appendix Table 1. Fiscal Rules Around the World, 2008

### Appendix Table 1. Fiscal Rules Around the World, 2008

### Key types of fiscal rules (as presented)
- ER = Expenditure rule
- RR = Revenue rule
- BBR = Budget balance rule
- DR = Debt rule
- Coverage abbreviations preserved: GG = General government; CG = Central government; CA = Cyclical adjustment
- Time frames reported: Annual; Multiyear; CA or Multiyear; Multiyear for ER; Multiyear expenditure ceiling; Multiyear for ER; Multiyear for ER; Multiyear (ER), Annual (BBR, DR)

### Major features and institutional arrangements (enumerated findings)
- Statutory, Constitutional, Political commitment, International Treaty, Coalition agreement are used as the statutory base across countries.
- Supranational frameworks cited include:
  - ECCU (Eastern Caribbean Currency Union) with a public-debt target of 60 percent of GDP by 2020.
  - Euro area; European Union (EU) fiscal rules: 3 percent of GDP deficit threshold and 60 percent of GDP debt threshold; aim at structural balances close to balance or in surplus.
  - WAEMU (West African Economic and Monetary Union) fiscal convergence criteria including balanced budget or better and public debt no higher than 70 percent of GDP.
  - CEMAC (Central African Economic and Monetary Community) limits on deficit and total debt; basic fiscal balance in balance or surplus; debt below 70 percent of GDP.

### Selected country-specific rules and exact numerical thresholds (preserved verbatim)
- Angola: ER (2005). Ceiling based on an oil price rule; government pre-determines spending envelope.
- Antigua and Barbuda: DR (1998); ECCU.
- Argentina: ER, BBR, DR (2000). Jurisdictions required to balance revenue and expenditure excluding investment in basic social and economic infrastructure and IFI-financed projects. Primary expenditure cannot grow more than nominal GDP or at most stay constant in periods of negative nominal GDP growth. Primary surpluses recorded since 2002.
- Australia: RR, BBR, DR (1998). Fiscal strategy statement covering the next four years. Expenditure rule restrains real growth in spending to 2 per cent a year once economy grows above trend.
- Austria: BBR (1999); ER (expenditure rule adopted in 2007, took effect with the 2009 budget).
- Botswana: ER (2003). Ceiling on the expenditure-to-GDP ratio of 40 percent.
- Brazil: ER, BBR (2000), DR (2001). Investment spending excluded from fiscal targets. Escape clauses for a real GDP contraction of 1 percent and natural disaster (require Congressional approval).
- Bulgaria: ER (2006). Ceiling on the expenditure-to-GDP ratio of 40 percent. DR: Outstanding consolidated government debt at the end of each year may not exceed the previous year's level in percent of the projected GDP.
- Cape Verde: BBR, DR (1998). Ceiling on domestic borrowing of 3 percent of GDP; debt ceiling of 60 percent of GDP.
- Chile: BBR (2000). Structural balance rule with independent body inputs. Targeted surpluses: a surplus of 1 percent of GDP targeted between 2002 and 2007; in 2008, 0.5 percent of GDP; in 2009, 0 percent of GDP.
- Comoros: BBR (2001). Balanced budget for the central government (Constitutional).
- Equatorial Guinea: BBR (2007). Fiscal rule based on the permanent income model and sustainable non-oil primary deficit. Authorities committed to reaching the sustainable non-oil primary deficit over the medium term. Response to the crisis was to sharply reduce the overall budget by over 40% and in particular capital expenditures.
- Estonia: BBR (1993). Balanced budget for GG.
- Finland: ER (1999), BBR (1999). BBR target of structural surplus of 1 percent of potential GDP. CG deficit must not exceed 2.5 percent of of GDP. Unemployment-related appropriations outside spending limits (about ¼ of total spending).
- Germany: BBR (1972). New structural balance rule (enshrined in the constitution in June 2009): structural deficit no more than 0.35% of GDP for the Federal government; structurally balanced budgets for the Laender. Transition period starting in 2011, full effect in 2016 for Federal government and 2020 for the states.
- Hong Kong SAR: BBR (1997). Political commitment; Annual coverage GG.
- India: BBR (2004). Current balance target. Escape clause in FRBMA allows non-compliance in exceptional circumstances as the central government may specify. Rule excludes public investment or other priority items from ceiling.
- Indonesia: BBR (1967); DR (2004). BBR: upper limit for general government deficit is set at 3 percent of GDP. DR: upper limit set at 60 percent of GDP. For 2009, the budget deficit is 2.4 percent of GDP while debt ratio is estimated at around 30 percent of GDP.
- Israel: ER (2005), BBR (1992). Multiyear expenditure ceiling. Deficit Reduction Law (DRL) adopted in 1991; limits real growth of central government fiscal expenditure. Rule excludes public investment or other priority items from ceiling.
- Kosovo: ER (2008). ER: Ceiling on current expenditure growth of 0.5 percent per year in real terms. Rules exclude public investment or other priority items from ceiling.
- Lithuania: ER, RR (2008), DR (1997). ER rule on average deficit over past 5 years; RR: deficit reduced by excess revenue of current year. DR: limits on CG net borrowing.
- Luxembourg: ER (1990), DR (1990). Multiyear expenditure ceiling; independent body sets budget assumptions.
- Madagascar: ER, RR, BBR (2006). BBR in cyclically-adjusted terms or multiyear. Rules exclude public investment or other priority items from ceiling.
- Mexico: BBR, RR (2006). BBR: Balanced budget on a cash basis. Starting with the 2009 fiscal year, definition changed to exclude investment outlays of Pemex. RR: Excess revenue distribution rules; oil stabilization fund to finance revenue shortfalls.
- Namibia: DR (2001). FRL in place.
- Netherlands: ER, RR (1994). Real expenditure ceilings fixed for government's four-year office term; multiyear expenditure ceiling.
- New Zealand: BBR, DR (1994). Fiscal Responsibility Act: (i) run operating surpluses annually until "prudent" debt levels are achieved, (ii) prudent debt levels maintained on average over a reasonable period, (iii) establish a buffer against adverse events. Governments set specific fiscal targets for 3-year and 10-year objectives, typically in percent of GDP.
- Norway: BBR (2001). Non-oil structural deficit of the central government should equal the long-run real return of the Government Pension Fund - Global (GPF) assumed to be 4 percent.
- Pakistan: BBR, DR (2005). BBR target balanced (current) budget by 2008 and surplus thereafter; DR target debt-to-GDP ratio to be reduced to 60 percent by 2012, by reducing public debt by no less than 2.5 percent of GDP per year.
- Panama:
  - BBR, DR (2002) (until mid-2009): Nonfinancial public sector deficit ceiling of 1 percent of GDP (excluding Panama Canal Authority), waiver in case of real GDP growth of less than 1 percent. Adjustment to 3 percent in the first year with gradual transition within 3 years. Debt-to-GDP target of 40 percent by 2014.
  - BBR, DR (since mid-2009): Waiver and new fiscal deficit ceiling of 2–2.5 percent of GDP, with gradual transition period extended to 4 years. NFPS ceiling relaxed if U.S. GDP grows by 1 percent or less for two consecutive quarters and monthly index of economic activity in Panama grows at 5 percent or less on average over a six-month period. Target date to reduce public debt-to-GDP ratio below 40 percent moved from 2014 to 2017.
- Peru: ER, BBR (2000). BBR: Deficit ceiling for the non-financial public sector of 1 percent of GDP. ER: Real growth current expenditure ceiling of 3 percent.
- Poland: DR (1997). Debt ceiling of 60 percent of GDP. Public Finance Act includes triggers for corrective actions when debt ratio reaches thresholds of 50, 55, and 60 percent of GDP.
- Portugal: BBR (2002). Balanced budget rule for CG. Rules exclude public investment or other priority items from ceiling at subnational levels.
- Spain: BBR (2003). In normal conditions GG must show a balanced budget or surplus. In downturns overall deficit must not exceed 1 percent of GDP. In addition, deficit up to 0.5 percent of GDP allowed to finance public investment under certain conditions. Exceptional clauses activated during current downturn; corrective plans put on hold.
- Sri Lanka: BBR, DR (2003). BBR: Deficit targets over a multiyear horizon. DR: Falling debt ceilings over a multiyear horizon. FRL in place. Exceptional circumstances clause.
- Sweden: ER (1996), BBR (2000). BBR: A surplus of 2 percent of GDP for the GG over the cycle targeted. ER: Nominal expenditure ceiling for CG and extra-budgetary old-age pension system.
- Switzerland: BBR (2003). Constitutional structural balance rule: one-year-ahead ex ante ceiling on central government expenditures equal to predicted revenues adjusted for cyclical position. Deviations are accumulated in a notional compensation account; if negative balance exceeds 6 percent of expenditures (about 0.6 percent of GDP) authorities required to take corrective measures within three years.
- Timor-Leste: RR (2005). Ceiling on the use of oil revenues.
- United Kingdom: BBR, DR (1997). Golden rule: GG borrowing only allowed for investment, not to fund current spending; sustainable investment rule: public sector net debt maintained below 40 percent of GDP over the economic cycle. Temporary departure from fiscal rules during global shocks; temporary operating rule to improve cyclically adjusted current budget each year once economy emerges from downturn.

### Institutional and procedural notes (key observations)
- Several countries embed fiscal rules in FRLs (fiscal responsibility laws) or constitutional provisions.
- Independent institutions or bodies set budget assumptions or provide inputs in countries such as Chile, Finland, Luxembourg, Netherlands.
- Escape clauses, waivers, and transition periods are commonly specified (examples: Brazil, Panama, India, Pakistan, Spain).
- Some rules explicitly exclude public investment or other priority items from ceilings (examples cited: Argentina, Israel, Kosovo, Lithuania, Mexico, New Zealand, Spain, Sweden).
- Supranational sanctions apply only to euro-area members under the EU framework.

*Sources: IMF database on fiscal rules, European Commission database on fiscal governance, IMF staff reports, and authorities' reports. Rules in effect in 2008.*

### Appendix Figure I. Selected EU Countries: Fiscal Rules and Public Debt, 1990-2008 1/

### Appendix Figure I. Selected EU Countries: Fiscal Rules and Public Debt, 1990-2008 1/

### Sources and construction of the fiscal rules index
- Sources: European Commission fiscal governance database; European Commission, Public Finances in EMU reports 2006, 2009; World Economic Outlook; and staff calculations.
- Fiscal rules index definition:
  - Based on five criteria of national fiscal rules: (i) statutory base of the rule, (ii) nature of the body in charge of monitoring the respect of the rule, (iii) nature in charge of enforcement of the rule, (iv) enforcement mechanisms of the rule and (v) media visibility of the rule based on self-reporting by EU Member States.
  - The index was standardized so that the average over the sample (1990-2008) is zero and the standard deviation is one.
- Chart axes labeling (as presented):
  - Fiscal rules index (rhs)
  - Public debt (% of GDP, lhs)
- Time coverage: 1990, 1992, 1994, 1996, 1998, 2000, 2002, 2004, 2006, 2008

### Countries displayed in the figure
- Belgium
- Bulgaria
- Denmark
- Finland
- Ireland
- The Netherlands
- Spain
- Sweden
- United Kingdom

### Implied informational content and analytic focus
- The figure pairs two series for each country over 1990–2008:
  - Public debt measured as “Public debt (% of GDP, lhs)”.
  - A standardized fiscal rules index measured on the right-hand scale labeled “Fiscal rules index (rhs)”.
- The fiscal rules index captures features of national fiscal rules across five institutional and visibility dimensions and is expressed in standardized units with sample mean zero and standard deviation one over 1990–2008.
- The presentation facilitates visual comparison of:
  - Changes in national fiscal-rule strength/profile (index) over time.
  - Trends in public debt as a percentage of GDP over the same period.
  - Potential co-movement or divergence between fiscal-rule indicators and public-debt trajectories at the country level for 1990–2008.

### Notes for interpretation
- Numeric and scale information preserved from source:
  - Sample period explicitly 1990–2008.
  - Index standardization: average over the sample (1990-2008) = zero; standard deviation = one.
- Axis labels indicate the left-hand series are percentages of GDP and the right-hand series are the standardized fiscal rules index values.
- The index construction relies on self-reporting by EU Member States for the “media visibility” criterion.

*Source: European Commission fiscal governance database; European Commission, Public Finances in EMU reports 2006, 2009; World Economic Outlook; and staff calculations.*

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