The views expressed in this presentation are the views of the author and do not necessarily reflect the

views or policies of the Asian Development Bank Institute (ADBI), the Asian
Development Bank (ADB), its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the data included in this paper and accepts no responsibility
for any consequences of their use. Terminology used may not necessarily be consistent with ADB official terms.

Fiscal Rules – Making Them Work

David Cowen, Director
IMF Capacity Development Office in Thailand (CDOT)

ADBI-UNESCAP Seminar on Fiscal Governance for

Sustainable Growth and Development
in the Asia and Pacific Region

April 24 – 25, 2019

Bangkok
What is a fiscal rule?
Definition of a (numerical) fiscal rule:

A fiscal rule imposes a long-lasting constraint on fiscal policy through

numerical limits on budgetary aggregates.

• The rule can be set in policy or by law, but has to have

been in place for a minimum of three years.

• This presentation only looks at fiscal rules that set

numerical targets on aggregates and capture a large
share of public finances.

2
The use of fiscal rules has been growing…
Number of Countries Using Fiscal Rules, 1990-2014

35
Advanced economies
Emerging market and middle-income economies
30
Low-income developing countries

25

20

15

10

0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Source: FAD Fiscal Rules database.
Notes: Figure includes both national and supranational fiscal rules. 3
 What should fiscal rules aim at?
The rule should be understood by decision-makers and
1. Simplicity
the public.

Compliance with the rule should suffice to ensure long-

2. Sustainability
term sustainability.

Following the rule should contribute to macroeconomic

3. Stabilization stability, or at least not add to volatility.

4. Operational It should be possible to translate the rule into clear

Guidance guidance in the annual budget process.

To build credibility, a rule should last and not be

5. Resilience abandoned after a shock.

It should be possible to verify if the government has

6. Verification complied with the rule. 4
There are several types of fiscal rules…..
DEBT RULES
Set an explicit limit for public debt
+ Direct link to debt sustainability
+ Easy to communicate and monitor
- No clear short-term guidance
- Can lead to pro-cyclicality
EXPENDITURE RULES
Limit total / primary / current spending
+ Clear operational guidance
+ Allows for economic stabilization
+ Relatively easy to communicate/monitor
- No direct link to debt sustainability
- Can lead to changes in composition
BUDGET BALANCE RULES
Constrain the evolution of the debt ratio
+ Clear operational guidance
+ Easy to communicate and monitor
- Can lead to pro-cyclicality
REVENUE RULES
Set ceilings or floors on revenues
+ Steers the size of government
+ Can improve revenue policy and
administration
- No direct link to debt sustainability
- Can lead to pro-cyclicality
5
The main trade-offs in choosing a fiscal rule

Credibility Flexibility

Flexibility Simplicity

6
 The use of fiscal rules varies internationally
Budget balance rules and debt rules
are most frequently used… …and often in combination.

Types of National Fiscal Rules in Use, 2013 Combinations of National Rules, 2013
(Number of countries with at least one fiscal rule) 60 (number of countries with the indicated
70
combination)
60 50

50
40

40
30
30
20
20

10 10

0 0
Revenue rules Expenditure Balance rules Debt rules ER+DR ER+BBR DR+BBR
rules
Source: IMF Fiscal Affairs Department (FAD) Fiscal Rules database.

Fiscal rules can take on many forms depending on countries’ choices

and priorities. 7
 Fiscal rules have had a positive impact on
sustainability…
• Countries with fiscal rules tend to run larger primary balances:
0.2

Yes
0.1
"Adjusted" primary balance

0.0

-0.1
No

-0.2

Fiscal rules

Source: IMF (2013)

Note: The “adjusted” primary balance takes into account all the other determinants of the primary balance included in the
regression, in particular the output gap, the debt level, and the existence of a fiscal council. 8
… but they can have adverse side effects
• Rules may lead to a weakening in the quality of fiscal policy:
– Induce governments to reduce easy-to-cut capital spending, which has
beneficial long-term growth effects
– Invite creative accounting and reduce transparency
– Distract from other priorities or lead to off-budget expenditure
/fragmentation of the budget process

• Some rules may entail a pro-cyclical stance in bad economic

times or fail to promote a counter-cyclical stance in good
times.

• Coordination with other macroeconomic policies is key:

– Monetary policy and exchange rate regime
– State of the financial system

An effective fiscal rule must reconcile fiscal policy with other

macroeconomic policies. 9
 Effective fiscal rules balance enforcement and
flexibility…
• A fiscal rule needs to be respected to build credibility.
• Many countries have now enshrined fiscal rules into law.
• Enforcement mechanism have also been developed:
– Automatic correction mechanisms: they specify in advance (in legislation)
when and how to correct deviations from the rule.
– Personal or institutional sanctions can ensure that cost of breaking fiscal rule
is greater than the benefit.
– Independent fiscal institutions (e.g. “Fiscal Councils”) help effective
functioning of rule by issuing early warnings, independent forecasts, and ex-
post evaluations.
– Mechanisms to ensure deviations are explained and justified: accountability!

• At the same time, flexibility is necessary to provide room to

maneuver, especially when an economy is weak, by:
– Incorporating strictly-defined escape clauses that add flexibility to fiscal rules.
– Limiting the application to some expenditure categories.
– Making use of structural balance rules, although these are difficult to manage.

10
 …and also rely on strong political commitment
and sound budget institutions
• Political commitment is crucial: the rule has to be understood and
supported by the political leadership

• Adequate PFM systems are required to implement a fiscal rule.

– Reliable data and technical forecasting capacity are important to prevent
large deviations from the announced fiscal policy stance and to ensure
compliance.
– Budget reporting systems should cover aggregates comprehensively and be
sufficiently developed to produce in-year and timely end-year reports.
– Internal and external audit systems are important to ensure accountability
– Public release of data allows external monitoring of compliance with the rule.

• Medium-Term Fiscal Frameworks are particularly useful to check

compliance with fiscal rules.

11
When have fiscal rules been more
successful or less successful?
More successful

– Under stable/good economic conditions (but not pre EU-crisis)

– For controlling local government finances
– When exiting from fiscal crisis: seen in some case (although they could
be a case of mistaken causality)

Less successful

– With lack of societal support

– During severe economic crisis
– In coping with all economic circumstances
– When they bite: induce avoidance/creative accounting

12
 Fiscal rules and fiscal responsibility laws (FRLs)
FRLs are useful instruments in supporting desired fiscal outcomes.
FRLs provide a legal framework that embeds in law an agreed set
of policies, processes, or arrangements intended to improve fiscal
discipline, transparency, accountability, and stability by requiring
governments to commit to monitorable fiscal policy objectives and
strategies.
– Their success depends crucially on appropriate design and wide political support
and acceptance.

Fiscal rules can make the requirements of FRLs more focused and
binding.
– Fiscal rules have to balance the requirements of enforcement with the need for
flexibility in accommodating changing economic circumstances.

– FRLs and fiscal rules need to be supported by adequate fiscal monitoring and
management capacities and be calibrated to country specific circumstances.
13
What is behind the need for FRLs?

• Debt and deficits paths:

– Unsustainable
– Pro-cyclical
– No consideration of inter-generational issues
• Lack of fiscal/budget discipline
• No anchor for fiscal policy
• Fiscal policy not a transparent, accountable, and/or
orderly process
• Sometimes no actual fiscal policy—budget policy drives
the day

14
What do FRLs comprise?

• FRLs often combine a number of the components below

and enshrine fiscal management requirements.

– Enhanced fiscal reporting

– Budget process rules
– MTFFs/MTBFs
– Fiscal councils
– Fiscal rules

15
Why use fiscal rules in FRLs?

• Provide clarity and specificity to fiscal policy (i.e. a fiscal

anchor).
• Demonstrate commitment by the fiscal agency.
• Offer a signal of fiscal sustainability to markets.
• If designed properly, provide an automatic, objective.
and non-political response to economic situation.

16
FRL Country Examples: Key Features

Chile – 2006 Fiscal Responsibility Act

– Fiscal Rule: Structural balance
– Established various funds including a pension and stabilization fund
– Increased fiscal reporting of contingent liabilities

Ireland – 2012 Fiscal Responsibility Act

– Fiscal Rules: General budget balance and debt rules, consistent
with Stability and Growth Pact; includes corrective mechanisms and
sanctions.
– Set out medium-term budgetary objectives
– Increased fiscal reporting
– Established a fiscal council

17
FRL Country Examples– Key Features

Peru – 2013 Fiscal Responsibility and Transparency Law

– Fiscal rules: Structural balance rule and debt rules, including
sanctions
– Required a medium-term macroeconomic framework
– Set out a fiscal stabilization fund for national government
– Established a Fiscal Council

Thailand – 2018 Fiscal Responsibility Act

– Fiscal rule on public investment
– Set up the National Fiscal Policy Board
– Required a medium-term fiscal framework
– Established process rules including on virements and setting of debt
limits
– Featured transparency and accountability requirements
18
Conclusions

 Fiscal rules need to be simple, transparent, and easy to

enforce.

 They should be sufficiently binding, backed by strong

political commitment, but also provide some flexibility to
accommodate changing economic circumstances.

 Fiscal rules can make the requirements of FRLs

themselves more focused and binding.

 FRLs and fiscal rules need to be supported by adequate

fiscal monitoring and management capacities.

19
 Thank you!

IMF Capacity Development Office in Thailand (CDOT)

c/o Bank of Thailand
273 Samsen Road
Phranakorn, Bangkok
Thailand 10200
Phone: +66 2283 6527
Email: cdotinfo@imf.org
https://www.imf.org/en/Countries/ResRep/CDOT-Region