Fiscal Rules: Make them Easy to Love and Hard to Cheat
IMF Blog, April 13, 2018
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Bibliographic details
- Authors: Xavier Debrun, Luc Eyraud, Andrew Hodge, Victor Lledo, Catherine Pattillo, Abdelhak Senhadji
- Published: April 13, 2018
Overview and central findings
- Rules to contain lavish government deficits are most effective if designed to be simple, flexible, and enforceable in the face of changing economic circumstances.
- Analysis covers fiscal rules in over 90 countries and finds rules put in place over the last three decades often were too complex, overly rigid, and difficult to enforce.
- Fiscal rules help prioritize budget demands, chart a predictable policy path, and keep public debt in safe territory; for example, limiting annual borrowing to 3 percent of the economy’s total income is a commonly used rule in many European countries.
- Better-designed rules can avoid excessive deficits, reassure financial markets and investors, and allow compliant countries to borrow more cheaply; conversely, countries with excessive deficits and lax rules have higher borrowing costs.
Features that enhance effectiveness (lessons from the past)
- Broad coverage: the rule should cover most, if not all, of the budget to reduce loopholes.
- Design that encourages saving in good times, e.g., preventing large expenditure increases that absorb revenue windfalls.
- Limits on fiscal aggregates based on sound economic principles; the debt ceiling should not be set too high or too low so as to balance fiscal responsibility and the ability to finance desirable policies (such as public infrastructure or offsetting large shocks).
- Precise exceptions to accommodate unexpected events, like natural disasters.
- Political buy-in and supporting institutions that enhance fiscal transparency and accountability—examples include fiscal councils that act as public watchdogs to evaluate fiscal policy.
- Recent reforms (a "second-generation" of rules) have made rules more flexible and easier to enforce by introducing better-defined exceptions and correction mechanisms (examples: Jamaica and Grenada introduced correction mechanisms in 2014 and 2015).
- These innovations have, however, made rules more complicated to operate with no discernible impact on compliance yet.
Three principles for future reforms
- Make sure the package of rules is consistent, parsimonious, and guarantees debt sustainability.
- Fiscal rules should include both a debt rule to set the course of medium-term fiscal policy and a small number of operational rules that guide annual budget decisions (for example, an expenditure rule or a budget balance rule).
- Reforms should ensure these rules are not redundant and do not send conflicting signals.
- Create incentives for better compliance with rules.
- Governments comply with their rules about half of the time.
- Compliance should bring more tangible benefits, and noncompliance should carry stronger costs.
- Financial sanctions are often not credible; raising reputation and political costs—notably via fiscal councils that monitor and expose possible mismanagement—appears more promising.
- Allow for adequate flexibility without sacrificing simplicity too much.
- Rules that permit deviations in response to economic shocks (for example, a budget balance rule) are often complicated and hard to implement.
- Expenditure rules may provide a better balance between flexibility and simplicity.
Policy implications and tailoring
- Countries should tailor the three principles (consistency and parsimony; incentives for compliance; flexibility with simplicity) to their own circumstances.
- Successful implementation requires complementary institutions and public accountability mechanisms to enhance rule credibility and enforceability.
Fiscal Rules: Make them Easy to Love and Hard to Cheat — April 13, 2018
Content in this bundle
- As regras fiscais devem ser fáceis de aplicar e difíceis de burlar
