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THE ISSUE (ON THE LEFT): Developing world following the trend


International Monetary Fund

THE ISSUE (ON THE LEFT): Developing world following the trend

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Should Barbados follow other countries and adopt special fiscal rules?

The number of emerging market and developing economies using fiscal rules as a fiscal policy device has increased rapidly since the mid 1990s.

The database of fiscal rules constructed by the International Monetary Fund’s Fiscal Affairs Department shows that while fiscal rules were initially confined to advanced economies, their use has rapidly gained momentum in the developing world.

As a result, emerging market and developing economies now largely outnumber advanced economies among fiscal rule users. In both groups of countries, the number of fiscal rules has remained broadly stable since the onset of the crisis, although there have been signs of renewed interest among emerging market and developing economies in the past couple of years.

As of end 2012, out of a total of 76 countries with one or more fiscal rules in place, 28 were advanced economies and 48 emerging market and development economies.

In addition to becoming part of the standard toolkit of currency unions around the world, fiscal rules have been often used in emerging market and developing economies to strengthen fiscal frameworks during and after large stabilisation and policy reform episodes. The great use of fiscal rules has not shielded emerging market and developing economies from procyclicality (correlation between the cost of goods and services and overall economic performance). In fact, unlike advanced economies, fiscal policy in emerging markets and developing economies remains procyclical following the adoption of a fiscal rule.

While it is impossible to establish causality, there is some partial evidence that some features of second general rules, such as the use of cyclically-adjusted targets, well defined escape clauses, together with stronger legal and enforcement arrangements, may be associated with less procyclicality.

The use of fiscal rules has indeed increased rapidly in the developing world. However, this does not seem to have been a factor behind the reduction in the procyclicality bias. In fact, adoption of fiscal rules in emerging market and developing economies has not been associated with more acyclical or countercyclical policies. More flexible rules and more supportive institutional arrangements could help reduce the procyclical bias associated with rules.

Without looking for causality, elements in the design of fiscal rules in emerging market and developing economies may be associated with a more procyclical fiscal stance than in advanced economies. Cyclically-adjusted targets and escape clauses are relatively uncommon in emerging market and developing economy rules, although they could play a stabilising role.

However, such flexible rules also call for higher quality institutional arrangements that strengthen monitoring and enforcement mechanisms. Better fiscal rules alone are unlikely to reduce the procyclical bias in emerging market and developing economies, let along enhance their fiscal capacity.

Reaching these ends will require improvements along with the whole gamut of the fiscal framework, from the selection of macro fiscal goals to the orderly management of budgetary accounts. However, crafting rules that allow for flexibility within the technical and political constraints facing emerging market and developing economies can still help tilt this larger effort in the right direction.

• These views were authored by International Monetary Fund economists Elva Bova, Nathalie Carcenac, and Martine Guerguil.

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