Promoting Counter-Cyclical Fiscal Policy: Fiscal Rules Versus Institutions

Abstract

We explore under different exchange rate regimes how fiscal rules and institutions can reduce the procyclical stance of fiscal policy (i.e. how government spending responds to GDP fluctuations). We construct a fiscal rules index which is a composite index measuring the overall strength of fiscal rules in a country at a given time. We use it in a dynamic model with a GMM estimator, for a panel of 153 countries over the period 1993-2015. We find that under fixed exchange rate regimes, while better institutions can reduce procyclicality, rules increase it or do not affect it. This result suggests that under fixed exchange rate regimes, a focus should be put on stronger institutional quality rather than on the adoption of fiscal rules. However, under flexible exchange rate regimes, we find that institutions and rules are complementary in reducing procyclicality. Rules help reduce procyclicality and are more effective, in particular, when institutions are stronger. Our results are robust to different specifications as well as to the use of alternative variables of institutional quality.

A Study on the Effects of Tax Reduction Policies on Fiscal Sustainability in China

“…'s use of this method to demonstrate that tax reduction policies increase the risk of local government debt [46]. The GMM method is a commonly used regression method in dynamic panel regression and has been widely applied in fiscal issues [47,48]. The adjusted R 2 value, AR (1), AR (2), and Hansen test p-value of this study are all within the effective range, further demonstrating the reliability and significance of the sample and research methods chosen in this paper.…”

Public Finance, Fiscal Rules and Public–Private Partnerships: Lessons for Post-COVID-19 Investment Plans

“…In the past years, EU countries’ investment has been compressed by the lack of fiscal space and budgetary consolidation operations that have impacted disproportionately on capital expenditures, because policymakers refrain from cutting government consumption to avoid voters’ frustration and find it easier to resort to investment cuts (Balassone and Franco 2000 ; Blanchard and Giavazzi 2004 ; Mehrotra and Välilä 2006 ). Furthermore, when fiscal policy is constrained by domestic and supranational fiscal rules, it can increase its tendency to pro-cyclicality and dump the adjustment on investment (Easterly 1999 ; Galì and Perotti 2003 ; Breunig and Busemeyer 2012 ), although evidence is debated (Bergman and Hutchison 2015 ; Gootjes and de Haan 2020 ; Keita and Turcu 2022 ) and the design of rules seems to be effective in mitigating the negative impact on the composition of public expenditures (Ardanaz et al 2021 ; Guerguil et al 2017 ).…”