Fiscal Rules: What Is Effective?

Synthesis of the analysis “Fiscal rules – what is effective?”:

  • Current fiscal crisis in the EU is, among others, a result of expansionary fiscal policy conducted in previous periods and especially during economic booms.
  • Large public debt undermined creditworthiness of the EU countries. Market confidence can be, however, regained through bold reforms of public finance. Persistence of the reforms to large extent depends on the efficiency of national fiscal frameworks. The crucial components of the latter are fiscal rules.
  • Fiscal rules are effective in correcting for deficit bias. The sole introduction of fiscal rule is, however, not sufficient for their efficient operation. Effective fiscal rules need to be credible. They should cover significant share of government finances, be relatively simple and elastic. They should also embrace exit clause, independent monitoring and pre-defined enforcement mechanisms. Moreover, fiscal rules credibility increases when they are enshrined in the law.
  • There are four main types of fiscal rules: balance budget, expenditure, revenue and debt rules. According to IMF the most efficient are balance budget rules (specified as structural and “over the cycle” balance) and expenditure rules. Budget balance rules influences positively debt sustainability and economic stabilization. The advantage of the expenditure rules is, in turn, contacting the size of the government. Even 20% of the countries which conducted successful fiscal consolidation had these two rules in operation.
  • The efficiency of balance budget and expenditure rules is documented in many empirical and case studies. For instance, in Chile and Estonia fiscal rules helped to sustain the debt at a low level in the long term. In Switzerland and Sweden, in turn, fiscal rules contributed to substantial fiscal consolidation.
  • In 2010 general government deficit in Poland reached 7.8% of GDP – the highest level since 1991. That means that the current fiscal framework in Poland is not effective in correcting for deficit bias. It is of primary importance, therefore, to introduce balance budget and expenditure rules which turned out to be efficient in other countries. It is also recommended to strengthen monitoring of country’s fiscal stance and increase public interest in fiscal policy. These goals can be achieved by introducing in Poland Fiscal Council.

Whole analysis can be read here (in Polish only).