Raimundo Soto - Catholic University of Chile Klaus Schmidt-Hebbel - Catholic University of Chile ERF Training on Advanced Panel Data Techniques Applied to Economic Modelling 29 -31 October, 2018 Cairo, Egypt

1. Datos de Panel 7
Raimundo Soto
Instituto de Economía, PUC-Chile

2. Fiscal Rules in the World
Klaus Schmidt-Hebbel
Raimundo Soto
Rethinking Fiscal Policy after the Crisis
L’udovít Ódor (ed.)
Cambridge University Press, 2017

3. Content
• Fiscal Rules and Fiscal Frameworks
• Contributions of this paper
• Empirical analysis
• Conclusions

4. Fiscal Rules and
Fiscal Policy Frameworks

5. Fiscal Rules
• Fiscal rules defined as:
– Permanent constraints on fiscal policy based on simple,
explicit, and quantitative targets or ceilings on budget
aggregates (Kopits and Symansky, 1998; Debrun and
Kumar, 2007; Schaechter et al. 2012)
• Rules are defined and implemented at
different government levels:
– National, supranational, subnational

6. Four main categories of fiscal rules
(i) Debt rules
(ii) Budget balance rules
– On different budget measures: overall, primary,
recurrent (golden rule); actual, cyclically-adjusted or
over the business cycle
(iii)Expenditure rules
– On different spending measures: total, primary, current
(iv)Revenue rules

7. Spreading of Fiscal Rules
• Fiscal rules started spreading in 1990s both
industrial and developing/emerging countries
– Only 4 countries had rules in place in 1982
– Increased to 48 countries in 2000 and 85 in 2013
• Most rules involve budget balance and public debt
• National rules vs supranational rules

8. Countries with Fiscal Rules
1985-2014
Source: IMF Fiscal Rules Dataset, 2015

9. National and Supranational
Fiscal Rules, 1985-2014
Source: IMF Fiscal Rules Dataset, 2015
National Rules Supranational Rules

10. Why do countries tie the hands of
fiscal policymakers?
• Democratically elected governments tend to have
biases toward excessive debt and deficits
• Fiscal discretion often leads to insolvency
• Biases in fiscal policy lead to (Fatás 2005):
(1) Fiscal policy volatility
(2) Fiscal policy procyclicality
(3) Unsustainable deficits and budget plans
(4) Intergenerational unfairness

11. Modern fiscal framework
• Shift in fiscal policy frameworks followed 1980’s
revolution in monetary policy frameworks
• Components of frontier fiscal framework:
– Constitutional or fiscal-responsibility law
– Procedural restrictions on budget adoption and execution
– High standards in policy transparency and accountability
– Planning horizon exceeding one year
– Effective external control and auditing
– Independent fiscal council
– Sovereign wealth funds
– Fiscal rules

12. General objectives of fiscal rules,
restrictions, and institutions
1. Strengthen fiscal solvency and sustainability
2. Contribute to macroeconomic (cyclical) stabilization (i.e.,
lowering policy procyclicality or raising
countercyclicality)
3. Strengthen resilience to government failures (i.e.,
reducing political-economy failures of fiscal policy)
4. Improve intergenerational equity

13. Benefits and costs of
fiscal restrictions and rules
• Benefits:
– Achieving the four latter objectives
• Costs:
– Compliance with rules and restrictions can be
macroeconomically costly under unforeseen shocks or
when rules and restrictions are too narrowly defined
– Lacking escape clauses, the latter can lead to
suspension of rules, eroding policy credibility

14. Previous Literature and
Contributions of this Paper

15. Literature on Fiscal Rules
• Growing literature on effects of fiscal rules:
– Fiscal performance
– Economic growth
– Welfare
– etc.
• Only three papers on determinants of adopting
and maintaining fiscal rules:
– Calderon and Schmidt-Hebbel (2008)
– Appendix of IMF (2009)
– Elbadawi, Schmidt-Hebbel, and Soto (2015)

16. Contribution
We extend substantially previous literature by:
(1) Specifying a framework encompassing six categories
of potential determinants of fiscal rules:
– Political and institutional variables, exchange-rate and monetary
regimes, capital account openness and financial development,
overall development, costs of having fiscal rules in place, and fiscal
policy conditions
(2) Conducting a broader empirical search based on:
– More countries and longer horizons
– Improved estimation techniques
– Robustness checks

17. Empirical Analysis

18. Empirical Analysis
• Rule definitions and scope
– Only national rules
– Any rule and by type (expenditure, revenue, budget
balance, and debt)
– Binary variable for rule (1=yes, 0=no)
• Data for 115 countries, 1985-2014
– 46 adopted a fiscal rule during the period
• High, medium and low income levels of all continents
– 69 did not have a rule
– Some countries abandoned rules (Argentina, Australia,
Canada, Iceland, USA)

19. Empirical Analysis
• Six categories of control variables
– Institutional factors: democracy (+), checks
and balances (?), federal countries (+), political
stability (+)
– Monetary systems: monetary union (+), fixed
exchange (+), inflation targeting (+)
– Financial development: cap. account openness
(+), financial development (+)

20. Empirical Analysis
• Six categories of control variables
– Overall development: per-capita real GDP at
PPP prices (+)
– Alternative cost of fiscal rules: second
moment of government revenue (-), second
moment of government balance (-)
– Fiscal conditions: fiscal deficit (-), dependency
ratio (-), procyclicality of gov. expenditure (-)

21. Empirical Analysis
• Econometric techniques for panel data models
with binary dependent variable
– Fixed effects (conditional logit)
– Random effects (probit)
• Change in probability vs probability level
• Low collinearity among control variables
• Lagged controls to reduce
endogeneity/feedback

26. Empirical Results (Part 1)
• Testing any national rule
– Random effects models:
• Sample (over 2,800 observations, 115 countries)
• Signs and significance of all parameters as expected,
except two very imprecisely measured (monetary
union, exchange system)
– Conditional fixed-effects models
• Sample (1,250 observations, 43 countries)
• Very similar results but much more imprecise

27. Empirical Results (Part 2)
• Test national rules by type
• Main Results
– Too few observations on “revenue rules” to trust
results
– Other models valid (according to tests and
judgment)
– Significant heterogeneity in terms of size of
coefficients
– Significant heterogeneity in terms of significance
– “Any rule ” models may be misleading (aggregation
bias)

28. Empirical Results (Part 3)
• Extend econometric models to include “any
supranational rule” as regressor
• General results do not change but for
supranational rule obtains:
• Expenditure: positive/significant effect
• Revenue: non-significant
• Budget balance: positive/significant effect
• Debt: non-significant
• Any rule: negative/significant

29. Main conclusions
• Fiscal reforms and fiscal rules are motivated by a myriad
of objectives. Then, why some countries adopt fiscal
rules while other do not?
• We answer empirically the following set of questions:
– Which institutional arrangements favor adopting rules?
– Are rules more likely associated to particular monetary and
exchange regimes?
– And to financial openness and economic development?
– Are richer countries more likely to adopt fiscal rules?
– Are better fiscal conditions conducive to adopt rules?
– Does revenue and fiscal volatility inhibit adoption of rules?

30. Main conclusions
• Institutional and political conditions contribute
significantly to the probability of having a fiscal
rule.
• While exchange regimes do not contribute,
inflation targeting is a significant determinant of
the probability of having a rule.
• Fiscal policy conditions also determine the
likelihood of having fiscal rules in place.
• Our measure of the alternative cost of having
fiscal rules inhibits their adoption.

31. Cuadratura
• El algoritmo de parametrización es de cuadratura y
dependen de cuantos puntos de integración se usen.
• Por defecto, xtprobit usa 12
• Tenemos que asegurar que los resultados no dependen de
la selección de puntos de integración.

32. Main conclusions
• Fiscal reforms and fiscal rules are motivated by a myriad
of objectives. Then, why some countries adopt fiscal
rules while other do not?
• We answer empirically the following set of questions:
– Which institutional arrangements favor adopting rules?
– Are rules more likely associated to particular monetary and
exchange regimes?
– And to financial openness and economic development?
– Are richer countries more likely to adopt fiscal rules?
– Are better fiscal conditions conducive to adopt rules?
– Does revenue and fiscal volatility inhibit adoption of rules?

33. Main conclusions
• Institutional and political conditions contribute
significantly to the probability of having a fiscal
rule.
• While exchange regimes do not contribute,
inflation targeting is a significant determinant of
the probability of having a rule.
• Fiscal policy conditions also determine the
likelihood of having fiscal rules in place.
• Our measure of the alternative cost of having
fiscal rules inhibits their adoption.