## 1. Central Government: DRL Ceiling Versus Actual Deficits, 1992–2009

## Source details

**Canonical URL:** [1. Central Government: DRL Ceiling Versus Actual Deficits, 1992–2009](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2008/_wp0887.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2008/_wp0887.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2008/_wp0887.pdf.json)

---

### I. Introduction and proposed anchor
- Ultimate objective:
  - Reduce public debt to "60 percent of GDP by 2015."
- Rationale:
  - "60 percent" seen as a widely considered benchmark and upper limit to protect from adverse growth shocks.
  - "2015" chosen because Israel’s population begins to age at an accelerated pace then; lower interest spending on public debt would permit greater pension and health care spending without triggering adverse fiscal dynamics.
- Desired rule characteristics:
  - Flexibility for uncertainty about the business cycle and exogenous shocks.
  - Built-in error correction mechanism that "caps the accumulation of public debt" to avoid large or systematic deviations from the ultimate fiscal anchor.
- Operational target:
  - Maintain central government balance (cash basis); typically equivalent to a general government deficit of 1 percent of GDP.
- Coverage note:
  - Government spending through the National Insurance Institute (NII) is equivalent to about 5 percent of GDP and is not currently included in the budget growth ceiling; health-related tax collection/outlays are also a potential loophole. Expenditures fully foreign financed may be considered for exclusion.

### II. Historical fiscal context in Israel
- Consolidation since 1985 stabilization:
  - "Public expenditure has been reduced by more than 16 percent of GDP" since the mid-1980s.
  - General government deficit reduced "from about 14 percent of GDP in 1984 to about 1 percent today."
  - Tax burden reduced "about 5 percent of GDP."
- Deficit Reduction Law (DRL) features and shortcomings:
  - Adopted in 1991 to incorporate medium-run fiscal targets.
  - DRL amended to include a real expenditure growth ceiling of "1.0 percent in 2004–05 and 1.7 percent since 2006" (excluding West Bank/Gaza disengagement and 2006 war).
  - Central government deficit ceilings for "2008 and 2009 are 1.6 percent and 1.0 percent of GDP, respectively."
  - DRL targets not adjusted for the cycle; prescribing an ex ante nominal deficit path created bias toward optimistic revenue projections in slow growth and pessimistic projections during strong expansions.
- Debt position:
  - Israel’s public debt ratio is "just over 80 percent of GDP" and remains high by international standards.

### III. Recent international experience with fiscal rules
- Definition:
  - Fiscal rule = "a permanent constraint on fiscal policy, typically defined in terms of an indicator of overall fiscal performance".
- Four categories of fiscal rules:
  - (i) Deficit rules.
  - (ii) Debt rules.
  - (iii) Expenditure rules.
  - (iv) Revenue rules.
- Benefits:
  - Numerical fiscal rules help contain spending and deficit biases; expenditure or debt ceilings have disciplined spending trends.
- Criticisms and risks:
  - Procyclicality: strict deficit and debt rules may force contractionary responses in recessions.
  - Rules silent on composition of adjustment can degrade fiscal policy quality.
  - Creative accounting and off-budget operations diminish transparency.
- Mitigating designs and institutional supports:
  - Cyclical adjustment, exclusions, and nonpartisan fiscal surveillance bodies (examples: Chile, Belgium, Sweden) improve credibility but raise complexity and implementation challenges.
- Flows vs. stocks tension:
  - Fixed flow targets can produce undesirable stock outcomes if nominal growth differs from assumptions; solution is an explicit feedback (error-correction) mechanism (example: Swiss "debt brake").

### IV. Swiss-like error-correction mechanism (ECM): design and properties
- Purpose:
  - Target the deficit over the cycle, record deviations in a fictional account, and set next-year planned deficit according to (i) cyclical position and (ii) balance of the fictional account.
- Functional specification (as provided):
  - The deficit, in percent of GDP, for the budget year 1t+ can be expressed as:
    - ()2 11 defdefTARygapFAFA tttt αβγ=−  +− ++ if   2−≤ t FA
    - 1 defTARygap t α=− + if   2−> t FA
  - Definitions:
    - defTAR = specified deficit target (1 percent of GDP for the general government deficit — equivalent to the central government balance operational target);
    - 1 ygap t+ = output gap projected in period 1t+; α = cyclical factor;
    - t FA = accumulated asset position in the fictional account at period t; β and γ are parameters between 0 and 1.
- Illustrative parameter assumptions used for scenarios:
  - public debt reaches 78 percent of GDP at end-2009;
  - output gap is zero when the rule takes effect;
  - 0.125βγ== and 0.4α= (revenue/GDP ratio).
- Properties:
  - ECM composed of a linear term and a quadratic term.
  - Becomes effective only once accumulated liabilities in the fictional account exceed a threshold (e.g., 2 percent of GDP).
  - Linear term reduces countercyclical policy as debt deviates from path; quadratic term imposes stronger adjustment when accumulated liabilities exceed threshold.
  - If economic dynamics are mainly cyclical, set 0γ= and choose β for preferred countercyclical stance; if dynamics are erratic or exposed to permanent shocks, choose higher γ.

### V. Scenario analysis — Swiss-like ECM (key illustrative results)
- Baseline scenario assumptions:
  - Rule takes effect in 2010; public debt expected to reach 60 percent of GDP by 2015.
  - Real GDP growth assumed to hover around potential between 2010 and 2017.
  - Accumulated liabilities in the fictional account never reach the 2 percent of GDP threshold; ECM not triggered.
  - Result: deficit path follows simple over-the-cycle process producing a debt path almost identical to a nominal (constant) central government balance (general government deficit of 1 percent of GDP).
- Negative output shock scenario:
  - Output gap reaches minus 10 percent of potential GDP by 2012.
  - Accumulated liabilities in the fictional account exceed 2 percent of GDP early; quadratic adjustment suppresses deficit rise and debt ratio reverts more quickly to baseline.
- Historical note:
  - Fictional account generated a total credit of around 1.3 percent of GDP between 2004 and 2006, largely due to under-execution of expenditure ceilings.

### VI. Expenditure rule with debt-feedback (debt-anchored expenditure ceilings)
- Motivation:
  - Preserve automatic stabilizers, avoid explicit output-gap measurement, and provide transparency by anchoring an expenditure rule on a long-run debt objective.
- Desired properties:
  - Trigger correction when debt deviates excessively from the norm.
  - Avoid explicit reference to business cycle measures (simplicity).
  - Be easy to communicate (transparency).
  - Reduce pro-cyclical contraction risk while encouraging allocation of windfalls to debt reduction.
- Core components:
  - (i) specific debt path to long-run objective (60 percent of GDP);
  - (ii) deficit norm consistent with that debt path;
  - (iii) medium-run (e.g., three-year) nominal expenditure growth cap consistent with the deficit norm.
- Two operational approaches:
  - First approach: set a constant maximum growth rate for nominal expenditure consistent with debt objective and adjust ceiling only if actual public debt deviates more than a specified margin (e.g., 5 percentage points of GDP) from the normative debt path.
  - Second approach: schedule regular revisions (e.g., every three years) of the expenditure growth ceiling following a formula that specifies how much past deviations from the debt norm are corrected.
  - Combining approaches possible but adds complexity.
- Trade-offs:
  - Revenue-side slippages (tax cuts, biased revenue forecasts) can undermine discipline.
  - Expenditure ceiling alone does not fully specify a debt path; link to ultimate objective may be weak.
  - Strict expenditure rules may hinder appropriate responses to unforeseen events; escape clauses may be unavoidable.
- Implementation example (three-year planning horizon):
  - Step 1: government sets desired debt-to-GDP path with fixed date for long-run target (60 percent by 2015).
  - Step 2: every three years set annual nominal growth ceiling for total government expenditure; if debt is above objective, ceiling ensures debt ratio declines at least as fast as the debt norm over planning horizon.
  - Ceilings binding and not revised during planning horizon except under exceptional circumstances or unacceptably large deviations.
- Operational safeguards:
  - If in any year k in [] 3;1 ++ ∈ xx , mdd kk + > * , where 0 > m is maximum deviation allowed from debt norm, define a new set of tighter expenditure ceilings covering years 1+k to 3+k.
  - Suggested range for acceptable deviations: 5 to 10 percent of GDP (source comment).

### VII. Comparative performance of alternative rules (2010–15) — selected indicators (percent of GDP)
- Rules compared:
  - Constant central government balance (general government deficit of 1 percent of GDP).
  - "Swiss" debt brake (Swiss-like ECM).
  - Alternative ECM debt brake (lambda=0.2).
  - Alternative ECM debt brake (variable lambda).
- Baseline scenario:
  - Root mean square deviation with respect to the norm path: 0.91, 0.90, 0.97, 0.97 respectively.
  - Mean error with respect to the norm path: -0.51, 0.02, 0.73, 0.72 respectively.
  - Difference from 60 percent in 2015: -1.44, -1.33, 0.13, 0.10 respectively.
  - Procyclicality (+ is procyclical; - is countercyclical): 1.43, 0.25, 0.14, 0.48 respectively.
- Negative output shock:
  - RMSD: 2.23, 3.75, 3.38, 3.39.
  - Mean error: -0.13, 0.65, 1.29, 1.26.
  - Difference from 60 percent in 2015: -2.67, -4.26, -1.89, -1.94.
  - Procyclicality: 1.79, -3.08, -0.41, -0.41.
- Amplified cycle:
  - RMSD: 5.09, 8.92, 9.11, 8.38.
  - Mean error: 4.51, 7.84, 8.55, 8.27.
  - Difference from 60 percent in 2015: 5.19, 9.07, 4.07, 0.34.
  - Procyclicality: 1.51, 0.04, -2.89, -4.09.
- Key comparative conclusions:
  - Debt-based ECM rules exhibit a lower pro-cyclical bent than the constant deficit rule, especially with pronounced cyclical fluctuations or large output shocks.
  - None of the proposed rules can entirely preclude procyclical policies; procyclicality is inherent in a deficit rule and can arise under ECMs when corrections are required or when the fictional account needs replenishment.
  - The expenditure rule targets the 2015 debt objective more precisely while allowing greater flexibility in response to shocks (higher RMSD). The Swiss ECM produces the largest negative deviation when cyclical fluctuations are pronounced because cyclical revenues are fully saved.

### VIII. Institutional considerations and implementation safeguards
- Required enhancements:
  - Stronger budget preparation procedures.
  - Stricter transparency requirements.
  - Improved medium-term fiscal planning.
  - Explicit analyses of long-run challenges.
  - Strong legal basis and nonpartisan fiscal surveillance, especially if escape clauses exist.
- Role of nonpartisan fiscal surveillance bodies:
  - Monitor developments in real time and assess compliance.
  - Provide unbiased forecasts and estimates of potential output growth and level.
  - Have a central role in changes to the debt norm.
  - In expenditure frameworks, validate existence of exceptional circumstances to trigger escape clauses.
- Accountability:
  - Establish clear mechanisms through which policymakers suffer loss if they do not abide by the rule to enhance credibility.

### IX. Conclusion — recommendation and caveats
- Two ECM concepts proposed to anchor a debt reduction objective while allowing fiscal stabilization and medium-run expenditure planning:
  - Variant on Swiss approach (cumulative deviations from cyclically adjusted deficit target recorded in a fictional account).
  - Expenditure growth ceiling with a debt-feedback component (debt-anchored expenditure rule).
- Trade-offs:
  - Swiss-like ECM: coherent with final goal and mindful of stabilization, but implementation complicated by explicit cyclical adjustment and parameterization challenges.
  - Debt-anchored expenditure rule: more transparent, arguably better aligned with existing Israeli framework, and more straightforward to communicate.
- Common requirement:
  - Enhanced transparency, governance, enforcement, and strengthened fiscal surveillance mechanisms are critical for credible implementation.

### X. Appendix (high-level): algebra for the debt-feedback expenditure rule
- Multiyear planning period s (example s = 3 years).
- If actual debt in year x is below normative path but above long-run goal d~, government preserves margin and reduces debt at same pace as norm.
- If actual debt is above norm, expenditure ceilings ensure faster reduction over s years along transitional path but do not overcorrect: xsxsxxtsxx dddd − ≤ Δ ++++ ** ,1 * ,1 .
- Functional form (source notation preserved) with adjustment speed x λ, 10<< x λ, and x λ increasing with extent of deviation but capped at 1.
- Expenditure ceilings in nominal terms s x x GG ++ ,..., 1 defined so that expected balances * ,1 sxx b ++ deliver the desired debt reduction ** ,1 d sxx ++ Δ given constant predicted growth rate g of nominal GDP.
- Operational safeguard: if deviations exceed m (suggested range 5 to 10 percent of GDP), define a new set of tighter expenditure ceilings; revisions allowed for exceptional circumstances.

*Source: _wp0887 - 1. Central Government: DRL Ceiling Versus Actual Deficits, 1992–2009, PDF chapter/section.*

### 1. Central Government: DRL Ceiling Versus Actual Deficits, 1992–2009 ..............................7

### 1. Central Government: DRL Ceiling Versus Actual Deficits, 1992–2009

### Main sections (chapter structure)
- 1. Central Government: DRL Ceiling Versus Actual Deficits, 1992–2009
- 2. International Comparison of Fiscal Rules
- 3. Comparative Performance of Alternative Fiscal Rules for Israel, 2010–15

### Figures included
- Figure 1. General Government Finances, 1980–2006
- Figure 2. International Comparison: General Government Finances, 2003–06
- Figure 3. Scenario Analysis One, 2009–17
- Figure 4. Simulated Debt Path Under Various Fiscal Rules, 2009–17

### Appendix
- Algebra for the Debt-Feedback Expenditure Rule

*Source: _wp0887 - 1. Central Government: DRL Ceiling Versus Actual Deficits, 1992–2009, PDF chapter/section.*

### References..............................................................................................................

### References

### I. INTRODUCTION
- Israel's public debt ratio is "just over 80 percent of GDP" and remains high by international standards.
- Recent framework (introduced four years prior to the paper) is considered untenable over the medium run; a search for a new rule is underway.
- Paper's proposed anchor: lower Israel’s public debt to "60 percent of GDP by 2015."
  - Rationale: "60 percent" is treated as a widely considered benchmark and upper limit, providing protection from adverse growth shocks.
  - The year "2015" is relevant because Israel’s population begins to age at an accelerated pace then; lower interest spending on public debt would permit greater pension and health care spending without triggering adverse fiscal dynamics.
- New rule characteristics emphasized:
  - Flexibility with respect to uncertainty about the business cycle and exogenous shocks.
  - A built-in error correction mechanism that "caps the accumulation of public debt" to avoid large or systematic deviations from the ultimate fiscal anchor.
- Paper structure (sections):
  - Section II: assesses Israel’s fiscal performance against its fiscal rules over the past two decades.
  - Section III: reviews international experience with fiscal rules.
  - Section IV: introduces a proposed new rule for Israel and presents scenario analysis and simulations.
  - Section V: discusses institutional considerations for effective implementation.
  - Section VI: concludes.

### II. FISCAL RULES IN ISRAEL — HISTORICAL CONTEXT
- Fiscal consolidation since 1985 stabilization:
  - "Public expenditure has been reduced by more than 16 percent of GDP" since the mid-1980s.
  - General government deficit reduced "from about 14 percent of GDP in 1984 to about 1 percent today."
  - Tax burden reduced "about 5 percent of GDP."
- Vulnerability remains: deficit reduction insufficient to protect fully against adverse debt dynamics during growth shocks (e.g., 2001–02 downturn).
- Deficit Reduction Law (DRL), adopted in 1991:
  - Called for incorporation of medium-run fiscal targets to compensate for lack of an anchor.
  - Successive governments found it difficult to meet deficit targets, particularly during weak economic activity.
  - DRL was amended to include a real expenditure growth ceiling of "1.0 percent in 2004–05 and 1.7 percent since 2006" (excluding West Bank/Gaza disengagement and 2006 war).
  - Central government deficit ceilings for "2008 and 2009 are 1.6 percent and 1.0 percent of GDP, respectively."
  - DRL targets were not adjusted for the cycle and required continuous amendment; prescribing an ex ante nominal deficit path appears to have created a bias for overly optimistic revenue projections in slow growth and overly pessimistic projections during strong expansions.
- Figure and international comparison notes:
  - Israel's debt position remains among the highest relative to OECD countries despite recent improvements in the deficit.

### III. RECENT INTERNATIONAL EXPERIENCE
- Definition and role of fiscal rules:
  - Fiscal rule = "a permanent constraint on fiscal policy, typically defined in terms of an indicator of overall fiscal performance" (Kopits and Symansky, 1998).
  - Growth in adoption of fiscal rules since the 1990s due to mounting public debts and evidence of destabilizing (procyclical) fiscal policies.
- Four broad categories of fiscal rules:
  - (i) Deficit rules (balanced-budget rules, golden rule, deficit limits).
  - (ii) Debt rules (limits on gross or net public debt).
  - (iii) Expenditure rules (ceilings on total spending or spending growth).
  - (iv) Revenue rules (limits on overall tax burden or allocation of windfalls).
- Benefits and criticisms:
  - Benefits: numerical fiscal rules have played an important role in containing spending and deficit biases by guiding or imposing constraints on policymakers’ discretion; expenditure or debt ceilings have had success disciplining spending trends.
  - Criticisms:
    - Procyclicality: strict deficit and debt rules may force contractionary responses in recessions; revenue rules can be procyclical if not ratio-based; expenditure rules allow automatic stabilizers to work but can permit drift in deficits and debt.
    - Deterioration in fiscal policy quality: rules are often silent on composition of adjustment, risking reliance on distortionary tax increases or cuts in productive expenditure (e.g., investment).
    - Creative accounting and off-budget operations: rules not backed by genuine commitment encourage manipulations, reducing transparency.
- Responses and complexities:
  - More sophisticated rules try to mitigate concerns (e.g., cyclical adjustment, exclusions), but complexity raises technical and institutional implementation issues.
  - Cyclical adjustment is technically challenging; defining spending categories is interpretive; complex rules are harder to implement and monitor, increasing manipulation risk.
- Institutional arrangements that support rule effectiveness:
  - Legal basis, enforcement procedures, and independent monitoring increase compliance and reduce manipulation.
  - Nonpartisan fiscal surveillance bodies can:
    - Provide unbiased macroeconomic projections and inputs to the budget process.
    - Analyze budget plans and implementation.
    - Formulate recommendations.
  - Examples:
    - Chile uses a panel of independent experts for cyclical assessment and revenue projections to minimize manipulation of cyclically adjusted-balance rules.
    - Belgium uses a nonpartisan body for coordination among entities for general government rules.
    - Sweden established a Fiscal Policy Council (Finanspolitiska rådet) to monitor compliance with fiscal objectives, including long-run sustainability, a surplus target, and an expenditure ceiling; it also assesses transparency and forecast quality.
- Flows, stocks, and the ultimate objective:
  - Tension between operational targets (flows) and ultimate objective (stocks) can create inconsistencies over time.
  - Examples:
    - A fixed primary surplus target can lead to excessive accumulation of government assets, which may be undesirable.
    - A fixed deficit ceiling may become inconsistent with debt outcomes if nominal growth differs from assumptions (example: under "5 percent nominal growth, a 3 percent deficit ceiling ensures public debt asymptotically converges to a number below 63 percent of GDP"; if permanent GDP growth is "4 percent per annum," the same deficit could guarantee stabilization below "78 percent of GDP").
  - Solution: introduce an explicit feedback (error-correction) mechanism adjusting flow targets to reflect stock developments (e.g., Swiss "debt brake").
- Swiss "debt brake" example:
  - Objective: balanced central government budget over the cycle through a one-year ahead ceiling on central government expenditure equal to projected cyclically adjusted revenue.
  - Allows deficits in recession and surpluses in expansion; over the cycle deficits and surpluses cancel out.
  - Trend GDP is calculated as an extrapolation of an HP-filtered historical output series.
  - Deviations from the cyclically adjusted balance are recorded in a fictional account; the accumulated balance of deviations determines the necessary adjustments.
  - The rule requires elimination of negative balances in the fictional account. If negative balance exceeds "6 percent of annual federal expenditure (about 0.6 percent of GDP)," the account must be brought down below 6 percent within three years (the debt-break mechanism).
  - Swiss performance under the rule is considered relatively strong, though implementation has been short; the mechanism was intended to govern central government budgets starting 2003 but took effect with the 2004 budget due to a large structural deficit in 2003.

*Italic source attribution line.*

### 0.9 percent of GDP in 2003 to a surplus of 0.5 percent of GDP in 2006, and gross debt has

### _wp0887 - 0.9 percent of GDP in 2003 to a surplus of 0.5 percent of GDP in 2006, and gross debt has

### Proposed objective and operational target
- Ultimate objective: reduce the public debt to 60 percent of GDP by 2015.
- Operational target: maintain central government balance (cash basis); this is typically equivalent to a general government deficit of 1 percent of GDP.
- Rationale for central government balance as target:
  - Authorities have direct policy control over it.
  - Local governments are relatively small and largely under central government control.
- Important coverage note: government spending through the National Insurance Institute (NII) is equivalent to about 5 percent of GDP and is not currently included in the budget growth ceiling; health-related tax collection/outlays are also a potential loophole. Expenditures fully foreign financed may be considered for exclusion.

### A Swiss-like error-correction mechanism (ECM) — design and properties
- Purpose: target the deficit over the cycle, record deviations in a fictional account, and set next-year planned deficit according to (i) cyclical position and (ii) balance of the fictional account.
- Error-correction mechanism features:
  - Composed of a linear term and a quadratic term.
  - Becomes effective only once accumulated liabilities in the fictional account exceed a threshold (e.g., 2 percent of GDP).
  - Linear term reduces countercyclical policy as debt deviates from path; quadratic term imposes stronger adjustment when accumulated liabilities exceed threshold.
  - Parameters β and γ are between 0 and 1 and determine speed of adjustment.
  - If economic dynamics are mainly cyclical, one may set 0γ= and choose β according to preferred countercyclical stance; if dynamics are erratic or exposed to permanent shocks, set higher γ.
- Functional/operational specification (as presented):
  - The deficit, in percent of GDP, for the budget year 1t+ can be expressed as:
    - ()2 11 defdefTARygapFAFA tttt αβγ=−  +− ++ if   2−≤ t FA
    - 1 defTARygap t α=− + if   2−> t FA
  - Definitions in the source:
    - defTAR is the specified deficit target (1 percent of GDP for the general government deficit—this is the equivalent to the operationally relevant target of central government balance);
    - 1 ygap t+ is the output gap projected in period 1t+; α represents a cyclical factor;
    - t FA denotes the accumulated asset position in the fictional account at period t; β and γ are parameter values (between 0 and 1).
  - Illustrative parameter assumptions used for scenarios:
    - public debt reaches 78 percent of GDP at end-2009 (assumption for scenarios);
    - output gap is zero when the rule takes effect;
    - 0.125βγ== and 0.4α= (revenue/GDP ratio).
  - Under these assumptions the rule is written (illustratively) as:
    - ()2 1   0.40.125 11 defygapFAFA tttt ⎛⎞ =−+− ⎜⎟ ++ ⎝⎠

### Scenario analysis and numerical illustrations (Swiss-like ECM)
- Baseline scenario assumptions:
  - Rule takes effect in 2010; public debt expected to reach 60 percent of GDP by 2015.
  - Real GDP growth assumed to hover around potential between 2010 and 2017 (an illustrative eight-year cycle).
  - Accumulated liabilities in the fictional account never reach the 2 percent of GDP threshold under baseline; ECM not triggered.
  - Resulting deficit path follows simple over-the-cycle process (1 defTAR ygap t α− +).
  - This produces a debt path almost identical to a nominal (constant) central government balance (general government deficit of 1 percent of GDP).
- Negative output shock scenario (illustrative):
  - Economy hit with significant slowdown in first three years after rule implementation.
  - Output gap reaches minus 10 percent of potential GDP by 2012.
  - Accumulated liabilities in the fictional account exceed 2 percent of GDP early on.
  - Quadratic adjustment suppresses deficit rise; by end of shock debt ratio more quickly reverts to baseline path.
- Additional scenario features shown in Figure 3 (as described):
  - Comparisons of public debt and deficit paths: baseline vs. negative output shock; deficit with and without debt-brake; output gap series (percent) for baseline and shock.
- Historical note from source footnote:
  - The fictional account generated a total credit of around 1.3 percent of GDP between 2004 and 2006, largely due to under-execution of expenditure ceilings.

### An expenditure rule with a debt-feedback (debt-anchored expenditure ceilings)
- Motivation and principles:
  - Anchor an expenditure rule on a long-run debt objective to preserve automatic stabilizers, avoid explicit output-gap measurement, and provide transparency.
  - Desired properties:
    - Trigger correction when debt deviates excessively from the norm.
    - Avoid explicit reference to business cycle measures (simplicity).
    - Be easy to communicate (transparency).
    - Reduce likelihood of forcing pro-cyclical contractions while encouraging allocation of revenue windfalls to debt reduction.
    - Allow for lower taxes if expenditure restraint is achieved.
    - Be resilient to unforeseen events unrelated to the business cycle.
- Core components of the rule:
  - (i) a specific debt path (the norm) to a long-run objective (e.g., 60 percent of GDP);
  - (ii) a deficit norm consistent with that debt path;
  - (iii) a medium-run (e.g., three-year) nominal expenditure growth cap consistent with the deficit norm.
- Two operational approaches to implement ECM on expenditure ceilings:
  - First approach: set a constant maximum growth rate for nominal expenditure consistent with debt objective and adjust the ceiling only if actual public debt deviates more than a specified margin (e.g., 5 percentage points of GDP) from the normative debt path.
  - Second approach: schedule regular revisions (e.g., every three years) of the expenditure growth ceiling following a formula that specifies how much past deviations from the debt norm are corrected over the period.
  - Combining approaches is possible (scheduled revisions plus reset if off-track) but can add complexity.
- Trade-offs and drawbacks of pure expenditure rules:
  - Revenue-side slippages (tax cuts, biased revenue forecasts) can undermine discipline.
  - Expenditure ceiling alone does not specify a debt path; link to ultimate objective may be weak.
  - Strict expenditure rules hinder appropriate responses to unforeseen events; escape clauses may be unavoidable.
- Implementation details (three-year planning horizon example):
  - Step 1: government sets desired debt-to-GDP path with fixed date for long-run target (here 60 percent by 2015).
  - Step 2: every three years set an annual nominal growth ceiling for total government expenditure.
  - If debt is above the long-run objective, ceiling must ensure debt ratio declines at least as fast as the debt norm over the planning horizon.
  - Ceilings are binding and not revised during the planning horizon except under exceptional circumstances or unacceptably large deviations from the debt norm.
- Simulations assumptions for expenditure-rule scenarios:
  - Three-year nominal expenditure ceilings are binding and met every single year to ensure constant reduction in the debt ratio.
  - Medium-run expenditure plans are based on trend GDP growth to allow for automatic stabilization.
  - No possibility to revise ceilings during the planning horizon (in the described simulation).
- Escape clauses and resets:
  - Step 1 (debt norm) can be revisited under well-motivated conditions (national emergencies, significant errors in long-run assumptions).
  - A debt trigger can be specified beyond which step 2 is repeated before the end of the normal planning horizon to preserve credibility and avoid politically infeasible adjustments.

### Comparative performance (summary indicators and trade-offs)
- Four rules compared (2010–15):
  - Constant central government balance (general government deficit of 1 percent of GDP).
  - "Swiss" debt brake (Swiss-like ECM).
  - Alternative ECM debt brake (lambda=0.2).
  - Alternative ECM debt brake (variable lambda).
- Selected indicators reported (percent of GDP, 2010–15):
  - For the Baseline scenario:
    - Root mean square deviation with respect to the norm path: 0.91 (Constant CG balance), 0.90 ("Swiss"), 0.97 (lambda=0.2), 0.97 (variable lambda).
    - Mean error with respect to the norm path: -0.51, 0.02, 0.73, 0.72 respectively.
    - Difference from 60 percent in 2015: -1.44, -1.33, 0.13, 0.10 respectively.
    - Procyclicality (+ is procyclical; - is countercyclical): 1.43, 0.25, 0.14, 0.48 respectively.
  - For the Negative output shock:
    - RMSD: 2.23, 3.75, 3.38, 3.39.
    - Mean error: -0.13, 0.65, 1.29, 1.26.
    - Difference from 60 percent in 2015: -2.67, -4.26, -1.89, -1.94.
    - Procyclicality: 1.79, -3.08, -0.41, -0.41.
  - For the Amplified cycle:
    - RMSD: 5.09, 8.92, 9.11, 8.38.
    - Mean error: 4.51, 7.84, 8.55, 8.27.
    - Difference from 60 percent in 2015: 5.19, 9.07, 4.07, 0.34.
    - Procyclicality: 1.51, 0.04, -2.89, -4.09.
- Key comparative conclusions (as drawn in the source):
  - Debt-based ECM rules exhibit a lower pro-cyclical bent than the constant deficit rule, especially with pronounced cyclical fluctuations or large output shocks—fiscal impulses can be countercyclical.
  - None of the proposed rules can entirely preclude procyclical policies; procyclicality is inherent in a deficit rule and can arise circumstantially under ECMs when corrections are required at the end of a planning period or when the fictional account needs replenishment.
  - The expenditure rule targets the 2015 debt objective more precisely while allowing greater flexibility in response to shocks (higher RMSD). The Swiss ECM produces the largest negative deviation when cyclical fluctuations are pronounced because cyclical revenues are fully saved.

### Institutional considerations and implementation safeguards
- Successful implementation requires enhanced transparency and governance:
  - Stronger budget preparation procedures.
  - Stricter transparency requirements.
  - Improved medium-term fiscal planning.
  - Explicit analyses of long-run challenges.
  - A strong legal basis and nonpartisan fiscal surveillance are vital, especially if escape clauses exist.
- Nonpartisan fiscal surveillance mechanisms/fiscal agencies/committees should:
  - Monitor developments in real time and assess compliance.
  - Provide unbiased forecasts and estimates of potential output growth and level.
  - Have a central role in changes to the debt norm.
  - In expenditure frameworks, validate existence of exceptional circumstances to trigger escape clauses.
- Accountability: establish clear mechanisms through which policymakers suffer loss if they do not abide by the rule to enhance credibility.

### Conclusion — comparative recommendation and caveats
- A debt-brake concept (two alternative ECMs proposed) can anchor a debt reduction objective while allowing fiscal stabilization and medium-run expenditure planning.
- Two ECM alternatives:
  - Variant on Swiss approach (cumulative deviations from cyclically adjusted deficit target recorded in a fictional account).
  - Expenditure growth ceiling with a debt-feedback component (debt-anchored expenditure rule).
- Neither is universally superior; trade-offs:
  - Swiss-like ECM: coherent with final goal and mindful of stabilization, but implementation complicated by explicit cyclical adjustment and parameterization challenges.
  - Debt-based ECM / anchored expenditure rule: more transparent, arguably better aligned with existing Israeli framework, and more straightforward to communicate.
- Both ECM types exhibit a lower pro-cyclical bent than a comparable constant deficit rule.
- Enhanced transparency, governance, enforcement, and strengthened fiscal surveillance mechanisms are critical for credible implementation.

### Appendix — algebra for the debt-feedback expenditure rule (high-level summary)
- Multiyear planning period: choose planning horizon s (e.g., s = 3 years).
- If actual debt in year x is below normative path *{T t d 0 * = τ τ} (i.e., * xx dd ≤) but above long-run goal d ~, government preserves margin and reduces debt at same pace as norm.
- If actual debt is above norm (* xx dd >), expenditure ceilings ensure faster reduction over s years along transitional path { s x x d + = τ τ ** } but do not overcorrect: xsxsxxtsxx dddd − ≤ Δ ++++ ** ,1 * ,1 .
- Functional form for required debt reduction over period (source notation preserved):
  - () and  if , ~ if  , and  if , ** 1 ** ,1 ** 1 ** 1 *** ,1 ** ,1 ⎪ ⎩ ⎪ ⎨ ⎧ < ≤ Δ == <> − − Δ = Δ + ++ ++++ xxxx sxx xxxxxxxx xsxx sxx dd dddd dddd d d λ , with () * xx ox dd − + = λ λ λ and 10<< x λ.
  - Adjustment speed x λ increases with extent of deviation but cannot exceed 1 (full correction in a single period).
- Expenditure ceilings can be defined in nominal terms s x x GG ++ ,..., 1 such that [] [] sxx sxx sxsxxxsxxxx YEbG YEbG +++++++++ − = − = * ,11 * ,111 ,..., τ τ .
  - x E is expectations operator conditional on information available at end of year 1−t.
  - * ,1 sxx b ++ is annual budget-balance needed over planning horizon to deliver desired debt reduction ** ,1 d sxx ++ Δ.
  - Expression for * ,1 sxx b ++ (source algebra):
    - () () ** ,1 0 )( )1( * ,1 11 11 dd g g b s x x s j js s s x x ++ = − − + − ++ Δ − ⎥ ⎥ ⎥ ⎥ ⎦ ⎤ ⎢ ⎢ ⎢ ⎢ ⎣ ⎡ + − + = ∑ , where g is constant predicted growth rate of nominal GDP.
- Operational safeguards:
  - If in any year k in [] 3;1 ++ ∈ xx , mdd kk + > * , where 0 > m is maximum deviation allowed from debt norm, a new set of tighter expenditure ceilings covering years 1+k to 3+k should be defined.
  - Revisions allowed to accommodate exceptional circumstances (defense, natural disasters).
  - Suggested range for acceptable deviations: 5 to 10 percent of GDP (source comment).

*Source: IMF staff analysis and proposals contained in the provided PDF content.*

### References

### _wp0887 - References

### Fiscal rules and institutions
- Beetsma, R., and X. Debrun, 2007, “The New Stability and Growth Pact: A First Assessment,” European Economic Review, 51, pp. 453–77.
- Bodmer, F., 2006, “The Swiss Debt Brake: How It Works and What Can Go Wrong,” Schweizerische Zeitschrift für Volkwirtschaft und Statistik 3/142 pp. 307–330.
- Danninger, S., 2002, “A New Rule: The Swiss Debt Brake,” IMF Working Paper 02/18 (Washington: International Monetary Fund).
- Debrun, X., L. Moulin, A. Turrini, J. Ayuso-i-Casals, and M. S. Kumar, 2008, “Tied to the Mast? The Role of National Fiscal Rules in the European Union,” Economic Policy, forthcoming.
- Kopits G., and S. Symansky, 1998, “Fiscal Policy Rules,” IMF Occasional Paper No. 162 (Washington: International Monetary Fund).
- Ljungman, G., 2008, “Expenditure Ceilings—A Survey,” IMF Working Paper, forthcoming.
- Lundback, E. J., 2008, “Medium-Term Budgetary Frameworks—What Can Austria Learn from Other Countries?” IMF Working Paper, forthcoming.

### Israel: fiscal consolidation and institutions
- Brender, A., 2008, “If You Want to Cut, Cut, Don't Talk: The Role of Formal Targets in Israel's Fiscal Consolidation Efforts 1985–2007,” Bank of Israel Lectures, Articles and Position Papers.
- Catalan, M., 2007, “Fiscal Institutions and the Political Economy in Israel,” Selected Issues, IMF Country Report No. 07/25 (Washington: International Monetary Fund).
- Debrun, X., and N. Epstein, 2008, “Toward a New Fiscal Rule: What Might Work Well for Israel,” Selected Issues, IMF Country Report No. 08/63, Chapter IV, pp. 43–69. (Washington: International Monetary Fund).
- Elekdag, S., N. Epstein, and M. Moreno-Badia, 2006. “Fiscal Consolidation in Israel: A Global Fiscal Model Perspective,” IMF Working Paper No. 06/253 (Washington: International Monetary Fund).
- Flug, K., 2006, “The Bumpy Road Towards Fiscal Consolidation: What is the Role of Fiscal Rules, Fiscal Policy in Israel since the 1990s,” presented at the Euro-Mediterranean Conference, ECB, and Falk Institute Annual Conference.

### Fiscal sustainability, sovereign risk, and methodology
- Celasun, O., X. Debrun, and J. D. Ostry, 2006, “Primary Surplus Behavior and Risks to Fiscal Sustainability in Emerging Market Countries: A "Fan-Chart" Approach,” IMF Staff Papers, 53 (3), pp. 401–25.
- Hallerberg, M., and G, Wolff, 2006, “Fiscal Institutions, Fiscal Policy, and Sovereign Risk Premia,” Deutsche Bundesbank Discussion Paper No 35/2006.
- Kumar, M., and T. Ter-Minassian, 2007, Promoting Fiscal Discipline, IMF.

### Related IMF analyses and working papers
- Debrun, X., and N. Epstein, 2008, “Toward a New Fiscal Rule: What Might Work Well for Israel,” Selected Issues, IMF Country Report No. 08/63, Chapter IV, pp. 43–69. (Washington: International Monetary Fund).
- Elekdag, S., N. Epstein, and M. Moreno-Badia, 2006. “Fiscal Consolidation in Israel: A Global Fiscal Model Perspective,” IMF Working Paper No. 06/253 (Washington: International Monetary Fund).

*Source: _wp0887 - References*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2008/_wp0887.pdf_