## Green Fiscal Rules? Challenges and Policy Alternatives

_IMF Working Papers, June 21, 2024_

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## Bibliographic details
- Authors: Francesca Caselli, Paulo A Medas
- Published: June 21, 2024
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9798400280726.001

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### Summary
- This paper studies the impact of green fiscal rules—designed to protect climate-related spending—on debt dynamics.
- Simulations for an emerging-market economy show that green rules that exempt green spending from rule limits can:
  - lead to unsustainable debt dynamics when the net zero emissions goal is pursued mostly using spending-based instruments (e.g., investment and subsidies); or
  - imply that the rule would need to implicitly assume a large fiscal adjustment in the non-green budget, undermining the rule’s credibility.
- The paper argues that building broad public consensus for a more comprehensive fiscal strategy is needed to address policy tradeoffs and long-term effects.
- A more appropriate mix of climate policies, including actively employing carbon pricing, should be pursued within the overall setting of fiscal and debt objectives.
- Developing ‘green’ medium-term fiscal frameworks would help integrate climate change considerations into fiscal policy design in a more comprehensive manner.

### Key findings and analysis
- Green fiscal rules that exempt green spending from fiscal limits can weaken debt sustainability if climate objectives are achieved primarily through public spending (investment and subsidies).
- To remain credible under such exemptions, the non-green budget would need to deliver large fiscal adjustments—an implicit and potentially unrealistic assumption.
- The interaction between climate policy design (spending-based vs. pricing-based instruments) and fiscal rules critically affects debt dynamics and the credibility of fiscal frameworks.
- Integrating climate considerations into medium-term fiscal frameworks (MTFFs) provides a more comprehensive approach than narrow exemptions in fiscal rules.

### Policy recommendations
- Avoid relying solely on expenditure exemptions in fiscal rules to protect climate-related spending without addressing broader fiscal and debt objectives.
- Pursue a policy mix that emphasizes carbon pricing alongside targeted public investments and subsidies to reduce pressure on public debt.
- Build broad public consensus for comprehensive fiscal strategies that explicitly tackle tradeoffs between climate objectives and debt sustainability.
- Develop and adopt ‘green’ medium-term fiscal frameworks to systematically account for climate-related spending and long-term fiscal effects.

### Scenarios and implications (as simulated in the paper)
- Scenario: Net zero pursued mostly using spending-based instruments (investment and subsidies)
  - Outcome: Risk of unsustainable debt dynamics under green-rule exemptions.
- Scenario: Rule assumes large fiscal adjustment in the non-green budget
  - Outcome: Undermines rule credibility due to unrealistic implicit assumptions.

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_Source: https://www.imf.org/en/publications/wp/issues/2024/06/21/green-fiscal-rules-challenges-and-policy-alternatives-550880_