Highlights:
- Fiscal rules have been adopted by over 100 countries in the last 20 years to manage public debt.
- These rules improve fiscal performance, such as lower debt, better budget balances, and more accurate forecasts.
- Well-designed fiscal rules don’t harm public investment and may prevent economic policy volatility.
- Emerging studies show that fiscal rules might also reduce political polarization and income inequality.
TLDR
Fiscal rules, which set limits on government spending, borrowing, and debt, have proven essential for improving public financial management globally. This article explores a study that reviews the wide-ranging impacts of these rules, showing how they contribute to lower debt, fiscal sustainability, and improved public investment strategies. However, the effects depend on the design and economic context, with some fiscal rules even influencing broader outcomes like political polarization and income inequality.
Fiscal policy is a critical aspect of economic governance, playing a crucial role in managing public resources, stimulating growth, and safeguarding financial stability. In recent years, more than 100 countries have introduced fiscal rules — regulations designed to limit the amount governments can spend, borrow, or hold in debt. In light of rising fiscal pressures, particularly following economic crises like COVID-19, such rules are becoming increasingly important. But what tangible impact do they have on public finances, and can they genuinely foster economic resilience?
A comprehensive review by economists Thomas Brändle and Marc Elsener sheds light on these questions. Their study, titled Do Fiscal Rules Matter? A Survey of Recent Evidence, delves into the effects of fiscal rules on various economic outcomes. It highlights how these rules are instrumental in shaping sound fiscal policies that withstand both economic booms and busts.
The Growing Importance of Fiscal Rules
Over the past two decades, fiscal rules have emerged as a key instrument for ensuring fiscal sustainability. These rules are often enacted to curb politicians’ tendencies to overspend, reassure financial markets, and build fiscal buffers that can be drawn upon during economic downturns. Following the global financial crisis and, more recently, the COVID-19 pandemic, many countries activated “escape clauses” to temporarily suspend their fiscal rules to facilitate massive public spending. As countries now begin to address their soaring public debt levels, these rules have come under closer scrutiny.
The research shows that fiscal rules are especially important in advanced economies where fiscal pressure is high. The authors discuss prominent examples like the German “debt brake” and the Swiss fiscal rules, which have been lauded for improving long-term fiscal health. In Germany, the Constitutional Court has debated whether the country’s strict fiscal rules can balance the need for infrastructure and decarbonization spending while maintaining fiscal restraint.
Impact on Fiscal Performance
The key finding from Brändle and Elsener’s survey is that well-implemented fiscal rules are consistently associated with better fiscal performance. Countries that adhere to these rules tend to experience improved budget balances, lower debt levels, and reduced volatility in public spending. More accurate budget forecasting is another notable benefit, making long-term fiscal planning more reliable.
For instance, a study by Badinger and Reuter (2017) found that countries with more rigorous fiscal rules showed better overall budgetary balance and lower economic volatility. A positive relationship between fiscal rules and improved sovereign bond ratings was also observed, as these rules signal fiscal discipline and reduce perceived risks among investors.
However, it’s not all about numbers on a balance sheet. Fiscal rules must be well-designed to be effective. The researchers emphasize the importance of flexibility, suggesting that rules should be adaptable enough to account for economic shocks without stifling necessary public investment or worsening economic cycles.
Do Fiscal Rules Harm Public Investment?
One common criticism of fiscal rules is that they could undermine public investment, particularly in infrastructure, healthcare, or environmental projects. However, the research presents a nuanced view. While some overly rigid rules might limit the government’s ability to invest, especially during fiscal consolidation, well-designed rules can safeguard public investments.
In fact, studies included in this review found that fiscal rules with built-in flexibility — such as provisions that allow for temporary deviations during economic crises — do not necessarily harm public investment. On the contrary, these mechanisms can help governments strike a balance between long-term fiscal sustainability and short-term economic growth. A study by Delgado-Téllez et al. (2022) supports this argument, demonstrating that flexibility in fiscal rules prevents pro-cyclical bias and protects public investment during economic downturns.
A Broader Economic Impact
Beyond fiscal performance, emerging literature is beginning to explore the impact of fiscal rules on broader political and social outcomes. There is evidence suggesting that countries with stringent fiscal rules experience less political polarization and reduced income inequality. For instance, studies on political economy dynamics point to how fiscal rules can create a more stable political environment by limiting the fiscal discretion of competing political parties, thereby reducing the scope for opportunistic fiscal policies that often deepen political divides.
Additionally, fiscal rules may contribute to more equitable wealth distribution by promoting responsible long-term economic planning. The research suggests that more accurate and transparent fiscal management encourages inclusive growth, benefiting both the government and the broader society.
Challenges and Future Directions
Despite their apparent benefits, the study acknowledges that fiscal rules are not without challenges. One of the key issues is the potential for governments to manipulate fiscal data to comply with these rules, a phenomenon known as “creative accounting.” To mitigate this, the researchers highlight the importance of independent fiscal institutions that monitor compliance and ensure transparency.
Looking ahead, the paper calls for further research into the long-term political and macroeconomic effects of fiscal rules. As more countries adopt these frameworks, understanding how they can be adapted to different economic and institutional contexts will be crucial for maintaining fiscal health in a post-pandemic world.
Conclusion
Fiscal rules have become a cornerstone of modern economic governance, especially in advanced economies with high public debt. As Brändle and Elsener’s review demonstrates, these rules contribute to improved fiscal performance, more reliable budget forecasts, and even political stability. The key, however, lies in their design — flexibility is essential to ensure that fiscal rules do not stifle public investment or economic growth. As countries grapple with rising debt in the wake of COVID-19, fiscal rules will continue to play a vital role in shaping sustainable economic recovery.
Source: Brändle, T., & Elsener, M. (2024). Do fiscal rules matter? A survey of recent evidence. Swiss Journal of Economics and Statistics, 160(11). https://doi.org/10.1186/s41937-024-00128-z