Fiscal Policy Rules

George Kopits, and Steven Symansky

• Publisher: INTERNATIONAL MONETARY FUND
• Year: 1998
• eBook ISBN: 9781557757043

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¹ Hence, this paper is closely linked to Kopits and Craig (1998).

² For a description of major types of fiscal policy rules, including institutional arrangements, see Appendix I.

³ From a semantic point of view, a fiscal rule may take the form of a budget norm (the Netherlands), reference value (EMU), guideline (Indonesia), or principle (New Zealand), among others. The term “rule” is rarely used in any country for statutory purposes.

⁴ According to Taylor (1993), several business cycles would be sufficient.

⁵ For a discussion of various, mostly temporary, budget norms in the Netherlands, see Oort and de Man (1968).

⁶ Inflation targeting, for instance, is to be observed both ex ante and ex post in some countries, but only ex ante in others. Exchange rate rules, whether in fixed or in preannounced crawling forms, are often specified within a wide band around a central rate. Also, the targeting of monetary aggregates or inflation in a number of countries is specified within a margin. The purpose of these margins and of exchange rate bands is comparable to the latitude provided for balanced-budget rules, namely, for accommodating the impact of unanticipated exogenous developments. For most of these rules, nonobservance is penalized by loss in reputation.

⁷ Financial penalties are usually imposed for violating an international treaty obligation—applicable for EMU or the CFA—by a country vis-às a supranational authority, but seldom, if at all, in the context of national or subnational rules.

⁸ As observed by Mussa (1994) with respect to monetary policy, the distinction between rules-based and discretionary regimes tends to fade when implementation of the former is widely open to interpretation and when the latter is applied with some degree of consistency and regularity.

⁹ The Budget Enforcement Act of 1990 in the United States is a recent example of a procedural rule (effective through 1998) whereby any excess discretionary spending over the specified limits is subject to sequestration by a uniform percentage across activities.

¹⁰ It may be noted that all stochastic simulations reported in Section III have been performed on contingent policy rules that broadly specify whether the rules-based adjustment takes place on the revenue or the (noninterest) expenditure side.

¹¹ See Masson and Mussa (1995) and Tanzi and Schuknecht (1995). Apart from the exceptional spending demands imposed by major wars and the Great Depression, fiscal policy in the industrial countries was relatively disciplined and debt ratios were stable until the early 1970s. To a large extent, fiscal rectitude was dictated by the needs of adhering to the gold standard and the Bretton Woods system. In essence, this period can be characterized as one of adherence to an implicit fiscal rule imposed by the existing monetary regime; see Laidler (1985) and Bordo and White (1993).

¹² This, in effect, was a departure from the policy prescription based on either a Keynesian or a neoclassical (“tax-smoothing”) approach.

¹³ See, for example, the evidence presented for the 1970–95 period in Latin America, in Gavin and others (1996).

¹⁴ Examples of medium-term fiscal consolidation plans launched in the industrial countries in the 1980s are the so-called Trilogy in Australia, the Deficit Reduction and Debt Control Act in Canada, the Goria Plan in Italy, the Medium-Term Financial Strategy in the United Kingdom, and the Gramm-Rudman-Hollings Act in the United States. Some of these plans were vitiated by creative accounting, overoptimistic macroeconomic fore-casts underlying the fiscal targets, and a lack of accountability for nonobservance of targets.

¹⁵ Between 1970 and 1995, out of the 74 episodes identified in IMF (1996a), there were only 14 documented cases of successful fiscal adjustment in industrial countries. Recent examples of significant and durable adjustment, underpinned by reform measures, can be found in Denmark, Ireland, the Netherlands, and New Zealand.

¹⁶ Among developing countries, the experiences of Ghana and Turkey since the early 1990s illustrate the unraveling of earlier successful fiscal adjustment. Subsequent adjustment programs have been adopted by Argentina in 1991 and Ghana in 1994. By contrast, Chile has pursued a sustained fiscal adjustment since the mid-1980s.

¹⁷ See Fischer, Sahay, and Vegh (1996), and Cheasty and Davis (1996).

¹⁸ On the contrary, there is ample evidence to support the view that a credible expenditure-based stabilization, in combination with structural reform, may be associated with an expansion toward trend growth and a deceleration in inflation. For industrial countries, see Alesina and Perotti (1996); for developing and transition economies, see Easterly (1996).

¹⁹ In the Netherlands, the rule was abandoned in the 1950s; in Japan, it was in effect suspended in 1975; and in Germany, it has been increasingly ignored in recent years.

²⁰ See footnote 13 above.

²¹ According to Buchanan and Wagner (1977), the balanced-budget rule is necessary to restrain the politically rational behavior of policymakers—reflected in the deficit bias—in response to the electorate’s failure to understand the intertemporal budget constraint. See the discussion of trade-offs in Corsetti and Roubini (1993).

²² See European Commission (1996, p. 23).

²³ As indicated in footnote 11, the exchange rate regime under the Bretton Woods system imposed, in effect, a rules-based constraint on fiscal policy—although not necessarily binding, since the peg could shift. Similarly, a currency board arrangement is not likely to be sustainable—except at a high cost in terms of crowding out or external indebtedness—without strict limits on domestic bank credit for the government. See Balino and Enoch (1997).

²⁴ See the criticism in United States (1995, Box 1–2).

²⁵ Likewise, a rule requiring a specified level of reserves under a public pension scheme, or other contributory entitlement pro...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Content Page
• Preface
• I Introduction
• II Rationale and Institutions
• III Economic Effects
• IV Evaluation of Fiscal Rules
• V Summary and Conclusions
• Appendices
• References
• Box
• Footnotes